The
prospect of an Italian budget deficit of 2.4% of GDP has unleashed extraordinarily
strong adverse comment by EU officials and politicians, from Draghi to Juncker,
from Dombrovskys to Mattarella, to former ministers like Moscovici and
Berlusconi (of all people!) who in their days in government have been among the
worst offenders of EU austerity constraints: they actually claimed that the
very existence of the Euro was under threat. They should have remained silent
at least until greater details of the budget were unveiled, in order not to
cause the market upset and rise in the spread between the yield on Italian and
German bonds, that they ostensibly feared but in truth whipped up and welcomed with
great enthusiasm. They were aided and
abetted by the media hysteria of Italian and European press and television;
deputy premier Di Maio rightly spoke of “media terrorism”.
Concern
was generally expressed about the sustainability of Italian debt, presumed to
be reversing its recent course of slow but steady decline as a proportion of
GDP. Yet the arithmetic of Debt/GDP ratio evolution over time is very simple
and well known, and in no way justifies concerns for a budget deficit of 2.4%,
nowhere near the sustainability limits. The point has been made only by Senator
Alberto Bagnai, president of the 6th permanent Commission for
Finances of the Italian Senate, in various posts on his blog http://goofynomics.blogspot.com/, and is well worth a
reminder.
The
budget balance f* that stabilizes the
debt/GDP ratio in year t is given by following relationship:
f* = d(t-1)*g/(1+g)
where
d(t-1) is the debt/GDP ratio
at the end of the previous year (t -1), and g is the nominal growth rate of GDP
in period t. A budget balance lower than f*
will necessarily involve a decline of the Debt/GDP ratio in the course of the same
year t. This is not a controversial theory, nor rocket science or high
mathematics, it is an incontrovertible relationship of simple arithmetic.
To
calculate this critical magnitude of the budget balance that will stabilise the
debt/GDP ratio in 2019, we need two values, both unknown in 2018 (i.e. today):
the value of the debt/GDP ratio at end-year 2018, and the nominal growth rate
in 2019. The IMF estimates that Italy’s Debt/GDP ratio at the end of 2018 will
be 129.7% of GDP, while GDP nominal growth in 2019 would be 2.5%, made up of 1.13%
growth, and about 1.4% inflation (IMF
World Economic Outlook, April 2018). Subsequent updates lowered real growth
by about one-tenth of a percent. Thus we can assume conservatively a 2019 real
growth of 1% and 1.4% inflation, i.e. a nominal growth rate of 2.4%.
By
the relationship mentioned above, the value of Deficit/GDP ratio f* sufficient to stabilize the Debt/GDP
ratio is therefore:
f* = 1.297(0.024/1.024)=3.03%
(more
precisely, 3.0398 i.e. almost 3.04%). The prospect of a 2.4% budget deficit amply
satisfies this constraint, leaving considerable room for contingencies; as it happens, the 2.4% deficit target also happens
to amply satisfy the Maastricht ceiling for the budget deficit (which no one proposed
to violate). Indeed a deficit rise with respect to the level embodied in
earlier growth estimates is bound to raise nominal growth as well above earlier
estimates, something that Ministers Tria and Savona were quick to point out,
but this is a minor additional argument in favour of current policies, with
respect to the powerful implications of 2.4%<f*.
Loose
and reckless talk is unbecoming of respectable officials and reporters. Regardless
of whether it is due to incompetence or malice, it breeds distrust and contempt,
though fortunately it also, in the end, raises popular support for the
government.
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