How Does the EU affect UK debt?

Readers Question: How are we tied up with the European Union in respect to the national debt? In short, the EU has little direct impact on UK national debt. If we were in the Eurozone, our bond yields  and debt situation would be very different. But, being outside the Eurozone means the UK debt is …

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How Should the NHS Be Funded?

A report by the Institute of Fiscal Studies suggests the NHS will need an extra £20 billion of funding by 2020.

The NHS already accounts for 23% of government funding, and is one of the few departments to be protected from budget cuts. But, in the age of austerity, spending commitments imply flat real spending increases for the next 5 years at around £110m.
govt-spending
The increased cost of the NHS is due to several factors:

  • An Ageing population. Older people tend to need more health care treatment. Around 50% of health care costs are in the last year of a person’s life. An ageing population places a greater burden on NHS treatment.
  • Increased availability of expensive medicines.
  • Increased expectations from patients.
  • Increased number of ‘lifestyle’ health problems, such as obesity related heart disease.

uk -health care

UK health care spending in real terms and as % of GDP

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What policies could Germany/EU use to help save the Euro?

Readers Question: What policies could Germany / the EU use to help save the Euro?

The Euro has many problems. The most obvious outer problem is rising bond yields and the threat of sovereign debt default. Related to sovereign debt default is a banking default, e.g. from Spanish banks which would cause knock-on effects. But, the problems of the Euro are deeper than just the issue of bond yields and debt default.

So far the current policy involves:

  1. Asking countries in trouble to pursue austerity and cut government spending – hoping that reducing budget deficits will restore stability to the bond market and avoid the need for further bailouts.
  2. Providing temporary loans to help governments meet the shortfall. e.g. the Spanish government are being given bailout funds so the Spanish government can bailout the Spanish banks.
  3. Structural reform and internal devaluation to help improve competitiveness in peripheral Eurozone countries

The impact of these policies have not been successful.

  1. Bond yields have continue to rise. Governments, such as Italy and Spain are still at risk of default.
  2. Austerity measures combined with overvalued exchange rates are pushing economies further into recession, which has harmed prospects of reducing debt to GDP.
  3. Internal devaluation risks taking too long to restore competitiveness

To Save The Euro, some or all of the following are needed.

  1. Joint liability of European debt. Eurobonds where debt is pooled.
  2. Direct recapitalisation of European banks
  3. Printing Money to buy bonds and provide liquidity for governments facing a liquidity crisis.
  4. Economic growth to give countries a chance to improve tax revenues and reduce debt / GDP ratios
  5. Restoring competitiveness amongst peripheral Eurozone countries who are struggling in the fixed exchange rate of the Euro.
  6. Structural reform / supply side policies which improves tax collection and improves productivity and competitiveness.

Policies to Save the Euro

Public Sector debt as % of GDP

EU Debt 2007-2010

Source: EU Stat

1. Appreciate nature of crisis. Firstly, there needs to be an appreciation that the Euro-crisis is more than just profligate spending in southern Europe,  In 2007, both Spain (35% of GDP) and Ireland (22% of GDP) both had lower public sector debt than Germany (63%). Government debt is a consequence of the crisis not the cause. At the moment, German finance ministers seem to suggest that if only southern Europe cut government spending all problems will be solved. But,  the main problems in Eurozone are:

  • Divergence in competitiveness causing a two speed Europe
  • Stagnant economic growth and high unemployment (European recession) Rising bond yields are partly a reflection of poor prospects for nominal GDP growth.

2. Pursue Economic Growth. Germany and the ECB need a general policy to attempt to reduce debt through growth, rather than reduce spending – even if it causes recession. The ECB should be given a dual target – not just low inflation, but also maintain economic growth and avoid a negative output gap. We need to end the deflationary bias which exists in the Eurozone.

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The Fed’s Reluctance to Print Money

Readers Question: Is the spectre of inflation the only reason the FED doesn’t simply print the US out of its economic troubles? By print, I mean at least print enough to pay down the debt to a manageable level, or create a major business incentive program using printed cash. Certainly, a big fear of the …

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Does Germany benefit or lose out from the Euro?

Readers Question: Does Germany Benefit from the Euro or does it lose out from the Euro because of the cost of bailing out weaker southern European countries?

It is a difficult question to answer, but Germany has gained many advantages from membership of the Euro. There are also many costs involved.

Firstly, you could look at the traditional benefits of the Euro (lower transaction costs, greater certainty over exchange rates). But, these seem relatively minor compared to bigger issues which have emerged.

Benefits to Germany of Euro

Very Competitive Exports. A key issue of Euro membership is that German exports are more competitive than if Germany had its own currency. Germany has seen the strongest productivity growth in the Eurozone area. Germany has been successful at increasing output and keeping wage costs low. If Germany still had the D-Mark, this increased productivity and low inflation would cause an appreciation in the D-Mark. But, with Euro membership, Germany hasn’t seen this appreciation against other European economies. Also, to non-EU countries the Euro is weaker than the D-Mark would be. The consequence is that the German export sector has done well because of improved competitiveness. This competitiveness is reflected in a large current account surplus.

current-account
Source: OECD – 2011

Germany has a large current account surplus nearly 6% of GDP – matched by a corresponding current account deficit in southern Europe.

Germany has seen a current account surplus since 2001

Source: Fallacies of Composition

Without membership of the Euro, Germany would have more expensive exports, higher unemployment and lower economic growth. This is the nature of a single currency – some will be ‘winners’ some will be ‘losers’.

From one economic perspective, the Euro may be better off without the strength of the German economy. (why Germany should leave the Euro) It is something of a paradox that German economic success (improved productivity, lower wage costs) can create problems. But, within the structure of the Eurozone, one country’s current account surplus, is another current account deficit.

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Would it Help to Buy Bonds from the Government?

Readers Question: If all Greeks native or from abroad (or any other country in debt) bought their own bonds would this make the debt much lower? No, it would not make the debt any lower. But, it would help to finance the government’s deficit. It would make it easier for the government to avoid a …

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Impact of Recession on Trend Growth Rate

Typically, a recession will lead to a negative output gap and lower inflation. However, after the recession is over, the economy can usually bounce back and recover this temporary loss of output. However, this ‘great recession’ is different in that there has been no bounce – only a prolonged recession – suggesting the usual expectations …

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Italian Debt Crisis

Italy has struggled to reduce national debt as a % of GDP since government debt has risen to over 100% of GDP in the late 1980s

National Debt Italy

  • Italy has the second highest public sector debt in Europe, after Greece. The IMF predict public sector debt of 123.4 % of GDP in 2012.
  • By 2013, Italian national debt is forecast to 123.8%

italy debt

 

Historical Italian National Debt

italian-debt

Source: Debt and Growth in G7 (up until 1970s, Italian debt was below 50% of GDP. Source: Krugman)

Italian Budget Deficit

Despite the large total debt, Italy has a relatively low budget deficit as % of GDP.

italy-deficit
Italian Deficit. Source: ECB

The Estimated budget deficits for 2012 and 2013 have been revised. The IMF predict that the deficit will be 2.4% of GDP in 2012, above the government’s own target of 1.6% (Reuters)

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