A new empirical analysis quantifies the (historic) link between public debt and economic growth. Critical thresholds depend on country features, such as access to financing. Average thresholds might be 60% and 80% of GDP for emerging and developed countries respectively. Importantly, debt dynamics matter more than levels. High debt is less of a drag when it is on a declining trajectory.
The surge in housing prices in metropolitan China is a systemic concern. A new paper estimates that price growth has been 8-13% per year from 2003 to 2013, comparable to the 1980s housing boom in Japan. Housing prices have averaged 8 times the annual income of buyers, implying a heavy financial burden. Sustainability relies on ongoing high household income growth and low real interest rates.
The latest IMF fiscal monitor underscores three key fiscal trends. First, deficits in the developed world keep narrowing, thanks to past fiscal tightening and present economic growth Second, public debt ratios remain high and are unlikely to fall back below 100% of GDP this decade. Third, emerging markets fiscal numbers are deteriorating.
A new McKinsey report estimates that total debt of households, corporates, and governments has expanded 40% since 2007, reaching a total of 286% of GDP last year. Government debt ratios will be hard to contain through fiscal tightening and economic growth alone. China’s non-financial debt has quadrupled, with credit quality critically dependent on the real estate sector.
With public debt ratios at their highest levels in two centuries, financial repression has become inevitable, representing the single viable alternative to default. Moreover, global fiscal tightening is still far from complete. Fiscal restriction will probably diminish in coming years if economic growth is exceeding real interest rates, but may come back with a vengeance if not.
The recent IMF fiscal monitor shows that advanced countries’ government deficit ratios have continued to narrow, due to fiscal tightening and – in some countries – better economic growth. However, public sector debt has inched up further and more restrictive fiscal policies will be required at some time in the future. Also, emerging market public finances have weakened.
A new ECB paper explains key risk factors of shadow banking. First, if unregulated finance outgrows market size, tightening liquidity can escalate into runs and fire sales. Second, if shadow banks are operated by regulated banks they become a source of contagion. Third, and most importantly, if shadow banking focuses on regulatory arbitrage it erodes classical financial system safety nets.
Financial repression is a policy that channels cheap funding to governments, typically supported by accommodative monetary policy. After the global financial crisis various forms of financial repression have prevailed in most developed and many emerging countries. These policies have been effective in containing public debt but bear risks for future financial stability.
With G7 public debt stocks at record highs, inflation has become a key fiscal concern. A new IMF paper estimates that a fall of inflation to zero would raise debt ratios by another 5-6%-points. A rise of inflation to 6% would lower debt ratios by 11-18%-points of GDP through real debt erosion. Inflation would offer additional fiscal benefits, such as higher revenues through “seigniorage” and progressive income tax tariffs.
The view that high public debt is bad for growth, popularized by Reinhart and Rogoff, has failed to find much empirical support in academic research. A paper by Lof and Malinen presents evidence that over the past 55 years lower growth has typically preceded higher debt but higher debt has not usually preceded lower growth.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
