What about private debt? MIP updates

Tomorrow I will receive two colleagues from the French Assemblée nationale (the equivalent of the Chamber of Deputies) who wish to explore the positions formulated by the Italian Parliament regarding the reform of the European budgetary rules, expressed in COM(2022) 583 , which I mentioned to you here , subsequently endorsed by the conclusions of the ECOFIN Council of 14 March , then approved by the European Council of 23 March .

I was rapporteur for the opinion of the XIV Commission, in whose work I participate as a permanent substitute for Minister Giorgetti. The opinion, which you find in the appendix here , was given to the Fifth Commission, which instead approved a document, rapporteur Mrs Lucaselli, which you find in the appendix here .

The documents are quite detailed and highlight a series of problems posed by the new regulatory approach proposed by Brussels. Of course, dealing with politics, we had to exercise the heroism of patience and not the "sicceroismo" of strollers. The temptation to follow the second approach, exemplified here by an author who believed he was on the left , naturally assails, but in a speech and in any case in a political context the rules of engagement are different. This obviously will not be understood by the usual purists who will turn up their noses, waiting to be purged by a more purist purist than themselves: but this is their problem.

Our problem, in general terms, as it emerges from reading the Commission's guidelines, is the usual one: that of rigid rules with discretionary application, immediately identified by the scientific literature as seriously dysfunctional , complicated in this case by a decisive input from opacity, and by the attribution of an ever greater power of impulse and management of the process to the Commission, that is to say to the deity who in the European Trimurti (Commission, Council, Parliament) is decidedly the most distant from direct democratic legitimacy. But it is not so much to this general aspect, variously highlighted (for the benefit of those who may have needed it) by the various subjects audited, that I want to draw your attention today.

Instead, I wanted to return to a point, which is the genetic datum of this blog: what about private debt?

Between the end of February and the beginning of March we spent three weeks talking about the need to put public finances in order, not to leave debt to future generations, and so on, and so far, please, understanding everything is forgiving everything! However, as strange as it may seem to you, for my colleagues not only does this blog not exist, where the point has been clear to us since November 16, 2011 , but neither does Voxeu, where they arrived on September 7, 2016 , and so the my colleagues do not know, alas!, that:

the last (and next) Eurozone crisis was not (and will not be) a public debt crisis, but a private debt crisis, a crisis of sudden stop of private refinancing of private debt positions on the abroad.

It was enough for us to observe that the worst-hit countries were those with the lowest, not the highest, public debt (the only exception was Greece, where, in any case, public debt was stable and private debt had grown rapidly). How could low or stationary debt cause financial problems? It was more likely that those problems were caused by a debt that was higher or growing rapidly!

We got there right away, the good ones five years later, my parliamentary colleagues still haven't got there. On this occasion, I open and close a parenthesis to underline a point, indeed, a couple of points of method.

Meanwhile, as you can see, we are beyond the principle of authority! Certain things are not understood, I don't say understood, but at least accepted, not even if Giavazzi, the prince of the new Pharisees, says them! The fact that the data tell you we can consider it as completely negligible, and why? But because on average a member of parliament does not have the time to investigate, and heavily discounts the reputational cost he would incur by relying on a source that turns out to be inadequate. You have also seen it recently: many had doubts (even in Speranza's party) but no one wanted to be saddled with the stigma of novax, that is, no one, in essence, wanted to lose the right to speak (because being discredited by the newspapers is equivalent to losing the right to express oneself). In short, what is true for parliamentarians is true for another institution in which reputational mechanisms play a decisive role: the markets. Even MPs would rather fail conventionally than succeed unconventionally. So are they stupid? No, far from it: they paint themselves like this! And isn't this irrational? No, it is not, unfortunately. The immediate cost of proposing an unconventional approach is the loss of the possibility of having an impact (obviously with the due exceptions and with the due distinctions, but not everyone has the necessary preparation and dialectic to venture into every field with the same effectiveness, which advises everyone to be very careful).

This parenthesis serves to counter the objection that many followers of guittology could make to me, and perhaps have even made to me, in the past: "But then you, who understand things first, why don't you explain them to him?"

But for two reasons: the first, which is the decisive one, almost everyone will understand: there is simply no time to do it (also because a discussion is done in twos, and to delve into a technical topic it is necessary not only that you wants to talk, but also that the other, who is short on time like you, finds it convenient to spend it listening to you). But the second, which hardly anyone will understand, is not negligible: simply, in saying things I don't say "as they are", or even "as they result from the data", but "as Giavazzi says them" (which is the maximum auctoritas for them) , I would be almost certain of losing the minimum of authority that I managed to acquire, and therefore of losing the possibility of being heard in other contexts.

He says: "But what's the point of not speaking to preserve the possibility of being able to do so in the future? In the meantime, you speak, then the facts will prove you right, as has already happened, and your authority will be strengthened!" Yes, it may be. But precisely, if the facts prove me right, why do I have to wear myself out getting things into people's heads that will find their way anyway? There is not a single game, there is not a single table, there are not only the rules, to say: there is so much more, and if it is clear that economic governance has its relevance, it is also clear that, in the eternal return of the same, the fact that we continue with austerity naturally has disadvantages, but it also has an indisputable pedagogical value. Even so, the balance of power changes, and it cannot be excluded that in many cases it is better to wait for them to evolve in one's favor before expressing oneself.

However, returning to the merits of the speech: what about private debt? Why, given that it is factually and scientifically established that episodes of financial instability mainly depend on it, is it not taken into account in the reform of the rules? Is it possible that in Europe no one has thought of it?

Of course it's not possible and of course it has been thought about, as I think you remember. Here we have often talked about MIP, the Macroeconomic Imbalances Procedure . By an irony of history, the European Union decided to include private debt among the indicators to be monitored on the very day we opened this blog to say that the problem was not the public debt (five years before Giavazzi) and in which Monti took office to carry out austerity, that is, to implement a policy fetishistically oriented towards the control of the public debt (with the applause of Giavazzi). In fact, the MIP is governed by Regulation 1176/2011 of 16 November 2011 . The fact is that, once their consciences had cleared up with a minimal circumstantial homage to macroeconomic common sense, Parliament and the Council then decided not to do anything about it: the entire corrective and sanctioning apparatus, in fact, remains anchored solely to public finance, and also the recent guidelines on the reform of the rules, while they tell us that:

an enhanced monitoring and enforcement process will also be foreseen for the MIP . The excessive imbalance procedure will therefore remain the tool to enforce policy action in Member States with excessive macroeconomic imbalances, including imbalances that jeopardize or threaten to jeopardize the proper functioning of the Economic and Monetary Union, when those Member States fail to take adequate political action

in practice they do not give any practical indication on how the State that finds itself in a situation of imbalance should be sanctioned or corrected (while for the public debt the control and sanction procedure is described in great detail, and you can find the text here ).

Perhaps the reason is what we predicted in 2015: if macroeconomic imbalances were taken seriously, it would turn out that we are not the worst off. An admittedly crude indicator we relied on was the average number of violations of the MIP parameters, which, we recall, are 14:

1. the three-term moving average of the ratio of the current account balance to GDP, with thresholds at +6% and -4%;
2. the ratio of the net foreign position to GDP, with a threshold of -35%
3. the 5-year percentage change in export market share, with a threshold of -6%
4. the percentage change over 3 years in unit labor costs, with a threshold of 9% (12% for countries outside the Eurozone
5. the 3-year percentage change in the real effective exchange rate based on the consumer price index and relating to 41 industrial countries, with a threshold of +/-5% (+/-11% for countries outside the Eurozone)
6. the private debt/GDP ratio, with a threshold of 133%
7. the ratio between private credit flow and GDP, with a threshold of 14%
8. the annual rate of change in the price of houses, with a threshold of 6%
9. the public debt/GDP ratio, with a threshold of 60%
10. the three-term moving average of the unemployment rate, with a threshold of 10%
11. the annual change in total liabilities of the financial sector, with a threshold of 16.5%
12. the change over three years in the activity rate (ratio between the active population and the population of working age), with a threshold of -0.2%
13. the three-year change in the long-term unemployment rate, with a threshold of 0.5%
14. the three-year change in the youth unemployment rate, with a threshold of 2%

(I have highlighted the three debts in bold: foreign, private and public).

Eight years ago the situation was this :

and as an exercise (and also to have something to say tomorrow), with great patience, I went to update the graph taking from the Statistical Appendix to the Alert mechanism report, i.e. from the Staff Working Document SWD (2022) 381 finals ,   the data from 2014 to 2021. The situation on the 2014-2021 sample (we do not have any more recent data yet) is this:

We note that the whole curve has lowered: eight years ago the worst performing country was Spain with an average of seven criteria violated per year, today Cyprus with 5.4 (followed immediately by Spain). The period of relative calm between 2014 and 2019 allowed all countries to adjust their parameters in some way, and so we too went from an average of 3.5 violations to an average of 2.9. The dynamics are of some interest: if eight years ago only five countries had collected on average fewer violations than us, in the period 2014-2021 the most "virtuous" countries, according to this admittedly crude criterion, went down to 10: we reached Finland , which is now tied with us, but we have overtaken Denmark, Sweden, Bulgaria, Romania, Poland and Malta. Unless I'm mistaken, five of these six countries are outside the Eurozone, and four are net borrowers of European funds, but this is definitely a coincidence. It is more interesting to observe that among the "big" four, only Germany is marginally better off than us, while France and Spain both have more difficulty than us in re-entering the framework of macroeconomic surveillance. Countries that proclaim great virtue, or that are heralded as virtuous by our media, are on par with us, like Finland, or rather worse than us, like the Netherlands. Ireland, the "wunderkind" of naïve storytellers, is the fifth country for the average number of violations (between Greece and Hungary).

This purely descriptive analysis, of course, takes its time. As important as it is to monitor the unemployment rate, especially the youth rate, and as much as it should be taken into account, the fact is that it is more a product than a cause of financial crises, which are instead caused by private debt, especially foreign debt . It being understood that the thresholds chosen for the net financial position and private debt do not have a particular value, just as the famous 60% does not have (which with the new European tax rules does not change), it may be interesting to focus on the violation of these three parameters: the second, sixth and ninth of the above list.

So let's see what evolution these three types of debt have had, examining their variation between 2014 and 2021:

Countries are sorted by change in external debt (net international financial position, blue bar) ascending, meaning that the topmost is the one that has reduced its debt the most (increased its credit the most) to the foreign countries, while the lowest is the one that has increased its debt the most (reduced its credit the most) towards foreign countries. At the top we have Croatia, whose net international position went from -89.6% of GDP in 2014 to -35.1% in 2021 (hence the net debt has reduced), and at the bottom we have Greece, whose position is went from -133.0% in 2014 to -171.9% in 2021 (so net debt increased).

This way of organizing the data shows us a regularity: generally the most competitive countries, whose exports exceed imports, and which therefore accumulate credits/decumulate foreign debts, i.e. those higher up, are also those in which the private sector manages to reduce its debt. The exceptions to this pattern are Germany, Sweden, Belgium, Austria and Slovakia. The same is true, broadly speaking, for public debt (and here Italy and Spain are the exceptions).

In some way this corroborates the emphasis on the advantages of competitiveness, ie growth with the demand of others: the problem obviously remains of how to imagine a world of only net exporters (who would care?), but I won't get into this age-old question now. Conversely, even if it would be interesting to go into the story of all the individual countries (for example Ireland, which we have dealt with several times, the last one here ), I propose a zoom on the four most important countries, because in the end, even if we managed to do ourselves a lot of harm by managing the crisis of a small country in the way you remember, it is the dynamics of the large countries that are decisive not only and not so much for the financial stability of the system, but for the guidelines of its legislative production:

The interesting thing is that between 2014 and 2021 in France all three stocks of debt increased, and not by a very small amount: public, private and foreign debt, as a reflection of the well-known problem of "twin deficits" ( public and abroad) that afflicts the country and on which we have talked for a long time over the years (probably them too, but without improving the situation much). This explains, for those who have listened only at this moment, certain slightly "moved" films that arrive from that country. Seen from this point of view, our position is not so dramatic. Of course, we have a lot of debt that everyone is talking about (the public one), and it has even increased (but less than in France). However, we got rid of the debts that no one talks about, which are the bad ones (foreign and private debts) at a rather satisfactory rate.

My provisional conclusion is that we are not the most fragile, if we use a less stupid metric than the one on which the discourse has flattened. But of course I'll keep this conclusion to myself, or at least I'll deliver it to a blog that doesn't exist.

(… and if I had to bet one euro on which country could give us satisfaction, I would bet it on Sweden: a country in which public debt has decreased and private debt has increased. It may not only have the initial in common with Spain, but we will see it …)

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This is a machine translation of a post (in Italian) written by Alberto Bagnai and published on Goofynomics at the URL https://goofynomics.blogspot.com/2023/04/e-il-debito-privato-aggiornamenti-sulla.html on Mon, 10 Apr 2023 17:45:00 +0000. Some rights reserved under CC BY-NC-ND 3.0 license.