Wednesday, May 26, 2010

It's not austerity if it's not austere...

Italy wants to cut its deficit to 3% of GDP.
However, a deficit is only sustainable if the rate at which the overall debt grows is smaller than the rate at which GDP grows.
Italy's Debt:GDP ratio is a bit over 100% (106% at the end of 2008 - If we say it's 110% now, a 3% of GDP deficit means that the country has to grow at about 2.73% (3% * 100%/110%) annually for its "austerity measures" to actually be sustainable.
Worse, because Italy is on the Euro, it can't just choose to inflate at will. Euro-sanctioned inflation has historically been very low. Additionally, even if Germany does consent to some inflation to help out Greece and Portugal, a lot of Italy's obligations are real obligations because they'll scale upwards with inflation anyway. The only major exception is interest cost.
If you believe that Italy would have to grow at 2.5% in real terms to make a 3% GDP deficit sustainable at today's credit rating and interest rates, you can't be optimistic about this "austerity plan". Italy's GDP growth has been well below 2% even before the recent recession, and many believe that Italy will struggle to hit 1% growth.
This is actually very generous, because it assumes Italy can survive indefinitely with the debt/GDP ratio at its current level. Italy's is very high right now, even relative to the rest of the overlevered developed world. If you look at some of the recent work that's been done on debt (Rinehart comes to mind), it finds that these debt levels aren't sustainable. The number they find is that above 90% debt/gdp, it's harder to sustain any degree of growth (reflected in Italy's poor growth estimates).
In other words, if Italy actually wants to be a factor in the world moving forward, it needs to run surpluses. It's not austerity if it's not austere...

No comments:

Post a Comment