Journal of International Economics 99(S1), March 2016, with Harris Dellas. PDF.
We develop a sovereign debt model with heterogeneous creditors (private and official) where the probability of default depends on both the level and the composition of debt. Higher exposure to official lenders improves incentives to repay due to more severe sanctions but it is also costly because it lowers the value of the sovereign’s default option. The model can account for the co-existence of private and official lending, the time variation in their shares in total debt as well as the low rates charged on both. It also produces intertwined default and debt-composition choices.
While the debt burden is commonly cited as being between 175 and 180 per cent of gross domestic product, this number is incorrect and indefensible because it is based on the face value of Greece’s debt that doesn’t take into account long maturities and concessional interest rates, as well as grace periods.
Greek debt, calculated on an International Public Sector Accounting Standards (IPSAS) basis, is significantly lower, and at the end of 2013 was 68 per cent of GDP. If this is not an appropriate method for measuring debt, then every company on major stock exchanges around the world has got its debt measurement wrong. In neither accounting standards nor economic principle is debt measured at face value. This pervasive misunderstanding of Greece’s real fiscal position has seen agreements reached between Greece and its creditors that do not address the real problem and instead may actually intensify it.
In a recent paper, Robin Greenwood, Sam Hanson, Josh Rudolph and Larry Summers discuss the joint effect of Fed and Treasury policy on the maturity structure of government liabilities in the hands of the private sector. John Cochrane commends the paper in a blog post.
Greenwood, Hanson, Rudolph and Summers make several points. First, “monetary and fiscal policies have been pushing in opposite directions in recent years.” In spite of QE, long-term government debt held by the private sector increased, mostly due to government deficits but also because the government lengthened the maturity of its debt. Second, Fed and Treasury policies largely are uncoordinated. They argue that this is suboptimal, in particular when the Fed strongly intervenes as it did in the recent QE episodes.
The Federal Reserve has focused purely on the effects that its bond purchases were expected to have on long-term interest rates and, by extension, the economy more broadly. … it completely ignored any possible impact on government fiscal risk, even though the Federal Reserve’s profits and losses are remitted to the Treasury. Conversely, Treasury’s debt management announcements and the advice of the Treasury Borrowing Advisory Committee (TBAC) have focused on the assumed benefits of extending the average debt maturity from a fiscal risk perspective, and largely ignored the impact of policy changes on long-term yields. To the extent that the Federal Reserve and Treasury ever publicly mention the other institution’s mandate, it is usually in the context of avoiding the perception that one institution might be helping the other achieve an objective. Specifically, the Fed does not want to be seen as monetizing deficits, while the Treasury has been reluctant to acknowledge the Fed as anything more than a large investor.
Third, they argue that from a consolidated government policy perspective, the optimal debt maturity structure is rather short. This saves on interest payments to the private sector (on average) and reduces “liquidity transformation” by the financial sector with dangerous consequences for financial stability. They downplay the risk sharing benefits of longer-term debt and argue that short-term debt has additional advantages at the zero lower bound.
Pages 11-12 contain the following figure, among others:
S. M. Ali Abbas, Laura Blattner, Mark De Broeck, Asmaa El-Ganainy and Malin Hu report in Vox about their debt structure database spanning the period 1900–2011 and covering Australia, Austria, Belgium, Canada, France, Germany, Ireland, Italy, the Netherlands, Spain, Sweden, the UK, and the US. Data is disaggregated along the following dimensions: Currency; maturity (of local currency debt); marketability; holders (non-residents, national central bank, domestic commercial banks, rest).
Their main findings are:
Advanced economies’ debt typically was denominated in local currency, with the exception of post-WWI France and Italy.
Governments issued longer-dated paper in good times.
The share of central government debt that was issued in the form of marketable securities declined until after World War II and increased again in the 1970s, to around 80% today.
National central banks and domestic commercial banks held about 30% of the debt until 1970. Afterwards, non-resident participation in sovereign debt markets soared.
Large increases in debt often were accompanied by a rise of short-term, foreign currency-denominated debt held by the banking system, with the exception of the 1980s and 1990s where more long-term local-currency marketable debt was issued.
Evidence for financial repression in combination with inflation after World War II.
They suggest that countries mainly followed two strategies to reduce debt quotas. One, based on fiscal consolidation and moderate inflation, going hand in hand with long maturities. The other, based on high inflation and reliance on debt holdings by captive domestic investors, going hand in hand with shorter maturities.