- May 29, 2011
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Yes, debt/GDP is about the expectations concerning the debtor's ability to service its liabilities and I.Harm's explained the crux well. If the creditor expectations worsen, yield demands ie interest rates on govt bonds usually start to go up, which makes market financing for govt expenditures more costly. I'd like to add one thing, which is about the distinction between issuers and users of a currency, which to me seems useful here.
Of the countries mentioned in this thread lately the US and Japan, for instance, issue the dollar and the yen whereas Greece does not issue the euro but merely use it. Their CBs and treasuries coordinate in pursuing economic policy goals, whichever they might be. In the case of Greece, it has its own treasury but the ECB conducts its monetary policy, and thus the link between monetary and fiscal policy is severed. So there is an asymmetry in terms of monetary sovereignty between these groups of countries. One group must finance govt expenditure via the market, whereas the other has more insulation because it may resort to self-financing. Sometimes I believe this procedure is called functional finance after Abba Lerner's works such as this paper, which discusses the role of govt deficits in attempting to maintain full employment at all times: http://k.web.umkc.edu/keltons/Papers/501/functional%20finance.pdf
As I understand it in the case of a severe crisis, exploding deficits needing to be financed etc, the US and Japan will always remain solvent (unless they choose not to, which would be something to behold!), because even in the hypothetical scenario that the financial markets think that they are not able to pay triggering the rising yields scenario that I.Harm depicted, they can always self-finance by "printing" money. Or more accurately they can credit bank accounts via their treasuries. But this option is usually moot, since the financial markets know that this is the case and thus know that barring extreme situations such wars or collapses of the taxation system such countries can service their debts in all conditions, so the ball is not even expected to roll that far. So the markets tend to treat these countries solvent at all times (see Japan).
On the other hand, Greece and the Eurozone countries in general cannot resort to such a manner of financing their expenditures via credit creation, since they are no longer issuers but users of a currency (the euro), and the ECB mandate a) very strictly forbids such an operation and b) it cannot measure its policy responses to fit the needs of a single country in a given situation but has to Consider the bigger picture (unless you are germany!). Thus monetarily non-sovereign countries may end up in the vicious circle of rising bond yield demands when facing a strong depression, just like certain Eurozone countries have since 2010. With contracting GDP and higher debt servicing costs the debt ratio is usually bound to increase too, which tends to worsen credit conditions, etc.
In this sense the debt/GDP ratio becomes a "hard" restricting factor for economic policy once countries give up their ability to issue their own currency, such as the Eurozone countries. So I agree 100% with I.Harm's assertion that demanding higher yields "was the rational thing to do given the circumstances of the Greek economy" in this situation. They had underestimated the risks of lending to Greece and acted accordingly.
For monetary sovereigns other factors such as deficit spending's effects on the inflation rate, cost competitiveness, exchange rate and so on tend to be more important, in my view at least than the debt GDP ratio. Bond vigilantes are always supposed to punish US and Japan for high govt debt levels, but somehow they never do.
A while ago someone asked what MMT stands for and I think the interrelated questions of monetary sovereignty and the role of the public sector are among the key questions for this school of economic thought and its attempt at explaining the modern monetary system, though I'm not an economist myself, just a social sci type. At least in Bill Mitchell's blogs there are several articles depicting the issue along roughly these lines, technicalities aside and possible misunderstandings mine, of course.
Edit: I.Harm also raises the very important point about Greece's growth and also that of Spain's. Even if the public debates tend to focus on public debt, it is in fact private debt and huge capital inflows seeking high yields in fast growing and inflating eurozone peripheral economies that fuelled the booms, especially in Spain. There real interest rates were at times even negative, since the ECB monetary policy stance was accommodating German very very low inflation conditions. In Greece it was a public-private thing, but the role of the private debt is more crucial, IMO. Once these money flows dried up, the houses of cards crumbled down. Simultaneously, countries had to bail out financial institutions that took bad hits while the financial flows from the central eurozone countries to the periphery dried up or even reversed, leaving huge amounts of private debt obligations unservicable, and thus effectively converted private debts into public ones.
Of the countries mentioned in this thread lately the US and Japan, for instance, issue the dollar and the yen whereas Greece does not issue the euro but merely use it. Their CBs and treasuries coordinate in pursuing economic policy goals, whichever they might be. In the case of Greece, it has its own treasury but the ECB conducts its monetary policy, and thus the link between monetary and fiscal policy is severed. So there is an asymmetry in terms of monetary sovereignty between these groups of countries. One group must finance govt expenditure via the market, whereas the other has more insulation because it may resort to self-financing. Sometimes I believe this procedure is called functional finance after Abba Lerner's works such as this paper, which discusses the role of govt deficits in attempting to maintain full employment at all times: http://k.web.umkc.edu/keltons/Papers/501/functional%20finance.pdf
As I understand it in the case of a severe crisis, exploding deficits needing to be financed etc, the US and Japan will always remain solvent (unless they choose not to, which would be something to behold!), because even in the hypothetical scenario that the financial markets think that they are not able to pay triggering the rising yields scenario that I.Harm depicted, they can always self-finance by "printing" money. Or more accurately they can credit bank accounts via their treasuries. But this option is usually moot, since the financial markets know that this is the case and thus know that barring extreme situations such wars or collapses of the taxation system such countries can service their debts in all conditions, so the ball is not even expected to roll that far. So the markets tend to treat these countries solvent at all times (see Japan).
On the other hand, Greece and the Eurozone countries in general cannot resort to such a manner of financing their expenditures via credit creation, since they are no longer issuers but users of a currency (the euro), and the ECB mandate a) very strictly forbids such an operation and b) it cannot measure its policy responses to fit the needs of a single country in a given situation but has to Consider the bigger picture (unless you are germany!). Thus monetarily non-sovereign countries may end up in the vicious circle of rising bond yield demands when facing a strong depression, just like certain Eurozone countries have since 2010. With contracting GDP and higher debt servicing costs the debt ratio is usually bound to increase too, which tends to worsen credit conditions, etc.
In this sense the debt/GDP ratio becomes a "hard" restricting factor for economic policy once countries give up their ability to issue their own currency, such as the Eurozone countries. So I agree 100% with I.Harm's assertion that demanding higher yields "was the rational thing to do given the circumstances of the Greek economy" in this situation. They had underestimated the risks of lending to Greece and acted accordingly.
For monetary sovereigns other factors such as deficit spending's effects on the inflation rate, cost competitiveness, exchange rate and so on tend to be more important, in my view at least than the debt GDP ratio. Bond vigilantes are always supposed to punish US and Japan for high govt debt levels, but somehow they never do.
A while ago someone asked what MMT stands for and I think the interrelated questions of monetary sovereignty and the role of the public sector are among the key questions for this school of economic thought and its attempt at explaining the modern monetary system, though I'm not an economist myself, just a social sci type. At least in Bill Mitchell's blogs there are several articles depicting the issue along roughly these lines, technicalities aside and possible misunderstandings mine, of course.
Edit: I.Harm also raises the very important point about Greece's growth and also that of Spain's. Even if the public debates tend to focus on public debt, it is in fact private debt and huge capital inflows seeking high yields in fast growing and inflating eurozone peripheral economies that fuelled the booms, especially in Spain. There real interest rates were at times even negative, since the ECB monetary policy stance was accommodating German very very low inflation conditions. In Greece it was a public-private thing, but the role of the private debt is more crucial, IMO. Once these money flows dried up, the houses of cards crumbled down. Simultaneously, countries had to bail out financial institutions that took bad hits while the financial flows from the central eurozone countries to the periphery dried up or even reversed, leaving huge amounts of private debt obligations unservicable, and thus effectively converted private debts into public ones.
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