The Kiel Institute Barometer of Public Debt

David Bencek, Henning Klodt 

The Kiel Institute barometer of public debt shows that the current commotion about Spain’s public finances is exaggerated (Table 1). Despite an increase of interest rates on ten year government bonds over six percent, Spanish public debt is still sustainable. According to our calculations, fiscal soundness is not at risk until interest rates rise beyond ten percent. Spain’s comparatively low level of public debt is a crucial factor in this regard; the debt to GDP ratio of Spain is far below that of Greece, Portugal or even Germany.

At the same time, the situation remains critical in Greece (despite the successful haircut on public debt) and Portugal. Further measures for debt restructuring are to be expected. The burden of debt for Ireland remains large as well. However, since medium-term growth prospects are positive Ireland’s potential for reducing its debt is still high. 

How Does the Debt Barometer Work?

The debt barometer uses the primary surplus concept to determine the sustainability of a country’s revenue and expenditure policies. The basic idea involved is that we do not know what the maximum limit to a particular country’s debt ratio is, but we do know that its debt ratio cannot rise infinitely because at some point the country would go bankrupt. 

The primary surplus is useful in determining the limits of a country’s debt only if it is coupled with criteria of how high the primary surplus ratio can go and how large the gap between the necessary primary surplus and the feasible primary surplus can become before the country will no longer be able to deal with its debt.

Our empirical assessment of historical developments in numerous countries leads to the conclusion that it is extremely difficult for a country to prevent its debt from increasing infinitely when the necessary primary surplus ratio reaches a critical level of more than 5%. When this level is exceeded for some time, it is almost impossible for a country to service its debt without receiving outside help (see Wirtschaftsdienst (Issue 9/2011)).

Since the ability of a country to service its debt is heavily dependent on its economic growth outlook and since predicting growth is fraught with uncertainties, the debt barometer incorporates two scenarios: a pessimistic scenario and an optimistic scenario. The former is based on a nominal GDP growth rate of 2%, the latter on a nominal GDP growth rate of 4%. These rates are long-term rates (not the rates during short-lived ups and downs in the business cycle) and would thus tend to be positive even in countries that have been hard hit by the financial and economic crisis. With respect to interest rates, both scenarios rely on information provided by the ECB on secondary market interest rates for ten-year government bonds.
 

Table 1: Primary Surpluses Needed in Particular Countries (as of April 2012)