Financial&economic sustainability of an economy Some exploratory remarks J.P. Fitoussi

1. Financial&economic sustainability of an economy Some exploratory remarks J.P. Fitoussi X. Timbeau Based on the OFCE workingpaper«  Financial&economicsustainability of an economy, Some exploratory remarks», available at www.ofce.sciences-po.fr xavier.timbeau@ofce.sciences-po.fr

2. Aim and method • Better understanding of financial of public and private sector situation • Starting from “usual” sustainability of public debt • To sustainability of public finance (public wealth account, private wealth) • To sustainability of debt, public and private • Long term sustainability has to do with wealth : wealth is a looking forward value; • Short term sustainability relates flow to flow (debt to gdp) • What is wealth ? • Financial Balance sheets • Assets (equity, pension funds); liabilities (debts) • Public sector and household : non Modigliani Miller theorem agents, debt is the only lever • In a closed economy, net worth of firms and financial sector is held by public or households • The concept of sustainability used here exclude sustainability of business (financial&non financial sector) • Financial and non financial balance sheets • Adding physical assets when available (balance sheets) • Correcting for pension funds and land value when possible JPF&XT

3. Part I : public debt • We will consider net debt • Gross (Maastricht) debt is improper for international comparison • Gross debt is a wrongful when used as a goal • Discussion over inclusion of sone entities in public debt is important when considering groos debt, much less when considering net debt • Gross debt is easier to manipulate • Gross debt leads to state reduction, not good governance • Stability of public debt is a short term indicator of (macro) public finance stance • Stability of public debt is linked to public deficit (or surplus) • sp being primary surplus, d net public liabilities (or net debt), g potential growth, gap output gap, r (real) interest rate • s* primary balance stabilizing debt is define ass* = - d (g – r) • Rot Tax gap is the gap between s* and structural primary balance (a negative tax gap means that net debt will be decreasing when gap will be null) is defined usually astax gap =sd- (sp - 0.5gap) JPF&XT

4. (rot) Tax Gap in 2013 for various countries • Tax gap is positive for most countries • Calls for a large reduction in public deficit Tax gap in 2013, as % of potential GDP Source : OECD Economic Outlook, june 2014. JPF&XT

5. Naivetax gap does’ntconsiderouput gap dynamic • Deficits are large because gaps are negative • But structural deficits are positive : long lasting impact of crisis • This is the usualcalculus • Reducingdeficitwill cause more gap (fiscal multiplier) • Gap dynamicwillbe to close, but in the meantime, balance isgoing to belessthan structural • That willadd up more debt and call for more structural surplus in the end • That isdependent on 2 key parameters : the soonerisyourtarget for debt, the harder ; the critical gap (r-g) plays a role, as well as g : deflationis a trap JPF&XT

6. Modelisation of debt dynamic • A simple « model » • is net debt (as a % of potential output); is primary public surplus (as a % of potential output); is structural primary surplus (as a % of potential output); isinterestrate;is rate of potentialgrowth; is output gap; is fiscal multiplier; • Rot taxgap is • is close to rot tax gap, plus a reduction of debt to a target • Similar to presentspecification of europeantreaties JPF&XT

7. Output gap dynamic, multiplier and surplus • Surplus is the sum of structural and cyclical surplus • Output gap is following a simple dynamic • Fiscal policy is measured as • Multiplier effect is set to zero in the long term • Cumulated fiscal multiplier depends on and • Tax gap is then With and Debt gap (and snowballeffect) Output gap loss Multiplier effect of consolidation JPF&XT

8. Dynamictax gap Source : authorscalculation, JPF&XT

9. Debt targets are overwhelming JPF&XT

10. Sensibility to key parameters JPF&XT

11. In 2007 thingswerelookingbetter JPF&XT

12. There couldbe a correlation… JPF&XT

13. Going one step further : financial accounts • A broader view on financial situation • Agregating households and public sector Financial wealth, %GDP, ranked on hedge Source : OECD Economic Outlook #95, june 2014, financial accounts, march 2014. JPF&XT

14. Evolution since 2007 JPF&XT

15. An evenbroaderview : includingphysical capital as well Financial&non financial wealth, %GDP, ranked on hedge Source : OECD Economic Outlook #95, june 2014, financial accounts, march 2014. JPF&XT

16. Evolution for France JPF&XT

17. Evolution for Italy JPF&XT

18. Evolution for United Kingdom JPF&XT

19. Evolution for USA JPF&XT

20. Evolution for Germany JPF&XT

21. That brings a slightlydifferent perspective on what’s to bedone • Reduction in net public debt for the samemeasure of sustainabilitythan in 2007 JPF&XT

22. Nevertheless, debttargets are implying large consolidation • One off global wealth tax (IMF) or permanent global wealth tax (Piketty) can solve the problem • General inventory of wealth, deal with tax heavens and tax evasion • 2 times column 5 as a marginal rate allow to exempt low wealth from taxation and tax « moderatly » high wealth • 2 times column 5 over 20 years implies annual taxation from .2% (DEU) to .8% (FRA) • Certainly better than defaulting; wich is nearly inevitable for ESP, GRC and PRT (and probably IRL) • Or, keep the debt as it is… *2007 net debt in 2034 JPF&XT