What is public debt?
Public debt is the debt of the government to the private sector of the economy (households, businesses, ordinary credit banks) and/or the Central Bank while, on the other hand, the private sector and/or the Central Bank are creditors to the government itself. Government debt is essentially created when in a State the expenditure is higher than the revenue. If this deficit cannot be covered by printing more money, the State issues bonds, the so-called “Treasury bonds” that, auctioned, are bought at a certain annual interest rate. The creation of public debt becomes a problem when public expenditure increases exponentially and this is not accompanied by adequate tax growth.
How big is Italy’s public debt?
Italy’s public debt hit a new record high in June 2019, reaching 2386.2 billion euros, a level never seen before. The population living in Italy is about 60.5 million inhabitants, so the public debt is about 35000 euros per head (men, women and children); this is an interesting fact: it is how much every resident in Italy should be taxed if, in theory, the state wanted to repay its debt in one fell swoop. However, the public debt is measured against the annual GDP: the main reason is that GDP represents the resources to which the State can draw (through taxation) to pay interest and, repay the debt on time.So the bigger the GDP, the easier it is to sustain a certain amount of public debt. In June 2019 Italy’s public debt is approximately 135%. Is it a lot? Is it little? There are two ways to understand it: the first one is to compare it with the past, the second one is to compare it with that of the other countries. Unfortunately there is no good news! A debt of more than 130% is high both from the point of view of Italian history and compared with that of other countries. In fact, the debt-to-gdp ratio only exceeded this threshold between 1919 and 1924 as a result of the high deficits accumulated during the First World War.
How the public debt is composed of?
The public debt is essentially “national”. In developed countries such as Italy, public debt is predominantly made up of government bonds (Treasury Bills, Btp, Cct, etc.). Almost 85% of Italy’s debt is made up of bonds of different maturity! It is also very important to let’s go see the composition of creditors, that is, whether the investors are Italians or foreigners. In fact, if the debt is held mainly by foreign investors, the risk of a crisis in the government bond market is higher because foreign investors are usually the first to go away if there are problems. By the end of 2014, only a third of the public debt was held by foreigners. That’s good…
A final question relating to the composition of public debt concerns the currency in which it is named. That’s a very important question! A State can get into debt in its own currency or in that of another country. The State can coin money; it can then finance its own deficit or borrow or print money. That’s a big difference: If the state gets into debt to fund its deficit, pay an interest and have to worry about renewing its maturing loans. Again, if you coin money, you don’t have to worry about all this.
So why isn’t the state financed by just printing money? The reason is that too much money in circulation ends up creating inflation. (In fact the main problems of hyperinflation in economic history were caused by the State, which failed to finance itself in other ways, printing too much money, which soon became waste paper).
What solutions for a reduction in public debt?
You might think of several shortcuts for reducing it.
- One of them is to repudiate debt, which is not to pay banks, financial markets; this would be very expensive, especially since two-thirds of the debt itself is held by Italians. Repudiating debt would mean taxing those who hold their wealth in government bonds and this would have a recessive effect; it would also suffer from the reputation of the Italian state as a broadcaster;
- Leaving the euro would also not do much: the presence of a central bank that can print money to repay the debt could reduce the risk of a crisis in the government bond market, but it would not avoid the need to correct public accounts, unless to be willing to inflation very high (and inflation is also a tax);
- Pooling public debt with our European partners would be nice, but it would demand a degree of altruism that we cannot have. Let’s be under no illusions!
What could then be a possible solution?
Increasing the GDP growth rate would greatly facilitate the debt reduction process, but there are several problems. First, the greater growth cannot be stimulated by a fiscal expansion as some argue: if you want to go one way you can’t start with going in the opposite direction. A moderate degree of austerity is necessary. The objective must be a balance of budget to be achieved within three years. This can be achieved without raising taxes. What is required is to keep primary spending constant; so it would be enough not to spend the increased revenue that comes from the higher expected growth. It would then be a matter of keeping it in balance, but only after the effects of the economic cycle. If this were done, public debt would fall below 90% of GDP by 2030.
In conclusion, reducing debt is not easy, but not impossible.
What is needed is to start a vicious circle in which debt reduction, and the resulting confidence, facilitates growth, increases state revenue, accelerating the debt reduction process. Of course it will take time and patience, but it is necessary to believe in it if we are to avoid being enslaved forever by debt and financial markets.