Highly indebted Eurozone states should take advantage of low interest rates to reduce debts, say EconPol economists

Highly indebted Eurozone member states should use the currently low levels of interest rates and the fact that growth rates exceed interest rates in some countries to reduce public debt, according to economists from EconPol Europe. Nevertheless, they say, current conditions should be utilized to boost one-time investment projects, particularly in countries where public investment has been low in recent years.

In a paper released today, Clemens Fuest (ifo) and Daniel Gros (CEPS) analyze the relationship between interest rates on government debt and growth rates, and the implications for the debt to GDP ratio.

The analysis shows that even if these conditions are sustained, current fiscal policies would lead to a further increase in public debt ratios, particularly for Italy and, to lesser extent, France. It would also be dangerous to question institutional restrictions on public debt in Europe, say the authors, leading to risk premia on government debt to rise, particularly in highly indebted countries.

The future path of interest and growth rates is unknown, they acknowledge, with many European countries expecting declining growth rates due to population ageing and the rise in related public spending. But, they say, efforts to achieve fiscal consolidation should not be abandoned, and questioning or abandoning institutional debt would be counter-productive.

Interest and growth differ considerably across European countries, along with the primary surpluses required to stabilize debt to GDP levels. Since 2015, the difference between interest and growth rates, which is key for the fiscal effort required to bring down public debt to gdp ratios, has been unusually low in Europe and negative for all countries except Italy. In particular Germany has benefited from the declining interest growth differential, so that its debt ratio has fallen over the last decade, without great fiscal effort.

There is scope and need for public investment in some member states conclude the authors. However, assuming that permanently laxer constraints on deficits would primarily lead to more investment is unrealistic.

Read the full paper: http://www.econpol.eu/publications/policy_brief_16