All five peripheral EU countries face burdensome public debt and budget deficits, but the causes for uncertainty in each country?s situation differ.Debts, Public ; Budget deficits

Silvio Contessi

English

Research Papers in Economics

Economic SYNOPSES
short essays and reports on the economic issues of the day
2010 ■ Number 22
T
he current international debt crisis has revived
fears that governments in some advanced economies
may default on their sovereign debt and unleash a
global financial tsunami. After September 2008 the per-
ceived risk of default on national debts by many peripheral
European Union (EU) countries (Ireland, Portugal, Spain,
Italy, and Greece) increased, spiking to levels not seen since
the introduction of the euro in 1999.1 Financial markets
demanded higher yields to keep buying the securities of
seemingly different countries. This disparate treatment
suggests two related questions: First, what determines the
growth of national debts? And second, why are investors
so worried about these countries?
The answers to these questions are related to a coun-
try’s overall fiscal soundness and debt sustainability. The
primary fiscal surplus of a country is the difference between
tax receipts and government outlays on current expendi-
tures (excluding interest on past debt; a negative surplus
is a deficit). Both long-term structural spending (such as
changes in military expenditures) and cyclical compo-
nents (such as unemployment benefits) contribute to fiscal
deficits.2 The primary surplus (or deficit) less interest pay-
ments on outstanding debt is the fiscal surplus (or deficit,
if negative). Therefore, the year-to-year change in nominal
government debt is the sum of two factors: the interest paid
on existing outstanding debt plus the primary deficit.
Higher interest rates and outlays and declines in tax
receipts tend to increase a country’s debt.
Government debt is typically indicated as a percentage
of gross domestic product (GDP); this allows meaningful
comparisons over time or across countries with respect
to ability to service the debt. Faster GDP growth relative
to debt permits governments to keep the debt-to-GDP
ratio under control. In contrast, meager economic growth
and/or little fiscal discipline can balloon the debt-to-GDP
ratio until the government develops fiscal discipline or
defaults on its debt.
The recent global recession has increased deficits and
debt-to-GDP ratios in many countries. Interest rates are
now favorably low but will likely increase as the global
economy strengthens, further increasing deficits and per-
haps making debts unsustainable.
Rising debt-to-GDP ratios of the five peripheral EU
countries partcularly concern investors, but fiscal pressures
are not unique to this group. The chart plots the debt-to-
GDP and deficit-to-GDP ratios for selected advanced
economies for 2007 and 2009; the average GDP growth
rate over 2003-07 is listed in parentheses.
All five peripheral EU countries (white dots on the chart)
face burdensome public debt and budget deficits, but the
causes for uncertainty in each country’s situation differ.
Italy has a large initial stock of debt and poor expected
growth. Ireland and Spain had lower debt coming into
2007 but experienced huge deficit increases. Portugal had
Sovereign Debt Shadows
Silvio Contessi, Economist
All five peripheral EU countries face
burdensome public debt and budget
deficits, but the causes for uncertainty
in each country’s situation differ.
–2
0
2
4
6
8
10
12
20 40 60 80 100 120
Debt-to-GDP Ratio (percent)
Deficit-to-GDP Ratio (percent)
UK
(2.7%) 
US
(2.8%) 
Japan
(2.1%) 
Greece
(4.3%) 
Spain
(3.5%) 
Portugal
(1%) 
Ireland
(5.3%)  Italy
(1.1%) 
France
(2%) 
Germany
(1.5%) 
180 200 220
Debt-to-GDP Ratios and Deficits-to-GDP in 
Selected Advanced Economies (2007 and 2009)
SOURCE: International Monetary Fund, World Economic Outlook database, 
April 2010; European Commission and Office of Management and Budget 
through Haver; European Central Bank, Financial Stability Review, June 2010.moderate debt but sizable deficit increases coupled with
slow projected growth. Greece had both large pre-crisis
debt and a ballooning deficit.
In all countries but Ireland common elements contribute
to fiscal concerns, including a high share of government
expenditure as a percentage of GDP, low fertility rates
(with fewer future workers to reduce the debt), and a large
informal economy. In addition, four countries (Ireland is
again an exception) currently spend or are projected to
spend in the future a larger share of their GDP to pay for
public pensions, relative to other advanced economies
(see Table). A final common element among these coun-
tries is membership in the euro area, which presumably
prevents the members of this group from inflating away
their debt.
Others countries might may soon face similar fiscal
pressures as the need for sizable pruning actions looms on
the horizon. ■
1 Measured by the rates on credit default swaps; see Neely, Christopher J.
“Markets Worry More about Sovereign Debt.” Federal Reserve Bank of St. Louis
International Economic Trends, February 2009;
http://research.stlouisfed.org/publications/iet/20090201/cover.pdf.
2 See Neely, Christopher J. “Global Factors in Budget Deficits.” Federal Reserve
Bank of St. Louis International Economic Trends, November 2003;
http://research.stlouisfed.org/publications/iet/20031101/cover.pdf.
Economic SYNOPSES Federal Reserve Bank of St. Louis      2
research.stlouisfed.org
Posted on August 4, 2010
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

Sovereign debt shadows

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