Prime Minister Mario Draghi returns to talk about the difference between “Good debt” and “bad debt”, and it does so on the occasion of a speech to all‘Accademia dei Lincei.
Draghi addresses various issues that affect the Italian economy, the European Union, the historic opportunity represented by the Next Generation EU, also demonstrating that he is not enchanted by the more reassuring data coming from the health front:
“The vaccination campaign is proceeding swiftly, in Italy and in Europe. After months of isolation and distance, we have resumed much of our social interactions. The economy and education have restarted. However, we must be realistic. The pandemic is not over. Even when it is, we will have to deal with its consequences for a long time. One of these is debt – the topic of my lesson today ”.
Draghi spoke of debt in relation to the function it can perform to boost growth. In turn, growth is a tool for managing debt containment.
Draghi: to grow more also to contain the increase in debt
“We must also grow more to contain the increase in debt. If we take the structural growth rate of the economy beyond what we had before the health crisis, we will be able to increase tax revenues enough to offset the increased debt we issued during the pandemic. We will also be able to create additional demand for companies, reducing the risk of default and therefore the cost of state guarantee programs on corporate debt. These are objectives that are not only desirable, but also achievable. As I said earlier, in these two years, the public debt in Europe and Italy has increased by about 20 percentage points of gross domestic product. Even if we use a conservatively high interest rate of 2.5%, the annual cost of this debt turns out to be about half a percentage point of national income per year. Since government revenues amount to about 40-50% of GDP in Italy and Europe, it is sufficient to increase the structural growth rate by 1-1.25 percentage points to cover the cost of debt of the last two years “.
Debt: an omnipresent topic when it comes to the Italian economy, given the monstrous debt / GDP ratio that Italy had well before the outbreak of the pandemic. However, the qualitative leap that Draghi has made has been to have identified the difference between good debt, in fact, and bad debt. The comparison is inevitable between today’s economic crisis and that of 2011, which had seen Italy as a sad protagonist together with Greece in the euro area sovereign debt crisis.
Of the dual nature of the debt, Draghi had also spoken recently, on the occasion of the presentation of the numbers of the Def:
“Good debt is when you give resources to a company, so that it can make such reforms as to become autonomous, and start flying on its own wings. Bad debt is made up of those subsidies that are paid out without there being an industrial plan“.
On the issue, Draghi returned precisely today, stating that “today it is therefore right to get into debt”, but also pointing out that “This is not always true”.
Good vs bad debt: Draghi returns to the difference
“This brings me to a distinction I mentioned a few months ago, between what I call” good debt “and what I call” bad debt “- said Prime Minister Mario Draghi in his speech today at the Accademia dei Lincei – What makes debt good or bad is the use made of the resources used. This distinction is particularly important in a transition phase like the current one, in which the differences in productivity between the projects in which it is possible to invest can be more marked ”.
Draghi continued:
“Debt can strengthen us, if it allows us to improve the well-being of our country, as happened during the pandemic. It can make us more fragile if, as has too often happened in the past, resources are wasted. Debt can unite us if it helps us achieve our goal of sustainable prosperity in our country and in Europe. But debt can also divide us, if it raises the specter of moral hazard and budget transfers, as it did after the financial crisis. Think, for example, of the common debt that finances the Next Generation EU. Our country is the main beneficiary of this program and therefore has a huge responsibility for its success. If we know how to use these resources productively and honestly, we will not only help the Italian economy. We will also strengthen trust within the European Union, making a decisive contribution to the integration process ”.
“More generally – continued the former ECB number one Mario Draghi in his speech at the Accademia dei Lincei – among the ways of using the public debt that qualify it as good debt are:
- The debt that is used to finance well-targeted public investments.
- The debt that allows to absorb exogenous shocks such as defense against a war or, indeed, a pandemic.
- The debt used to make countercyclical politics.
Draghi takes the 2011 crisis as an example
“The countercyclical fiscal policy it is particularly important in a monetary union, because monetary policy cannot respond alone to the isolated shocks that hit a country. It is even more so today, when the proximity of interest rates to their effective lower limit reduces the ECB’s ability to independently support aggregate demand. However, not all eurozone countries are equally capable of using fiscal policy as a stabilization tool. Sovereign debt that is not considered safe only partially permits this, because its issuance can lead to higher interest rates. Only the debts of some countries are in fact considered completely risk-free by the markets. They can issue all the debt necessary to counter the decline in private demand during a crisis without causing an increase in interest rates ”.
“An example is what happened during the 2011 crisis – Mario Draghi recalled – The public debt of some countries such as Italy was not considered safe by investors just when governments needed to issue it to respond to the crisis. The fiscal space for these countries shrank just when they needed it most because their interest rates have risen. In recent years, the ECB has solved this problem thanks to an expansionary monetary policy, justified by the fact that inflation in the medium term continued to be much lower than its primary objective. This has prevented economies from falling into a vicious circle, such as that of 2011, where the lack of security in public debt generated increases in interest rates that led governments to implement restrictive policies in an attempt to gain credibility. Growth was affected, credibility in these countries declined and rates continued to rise. To date, the inflation rate within the euro area continues to remain low and require accommodative monetary policy. However, these circumstances may not be repeated in the future if inflation expectations are to sustainably exceed the ECB’s statutory target. At the European level, we must therefore think about how to allow all Member States to issue secure debt to stabilize economies in the event of a recession. The discussion on the reform of the Stability Pact, for now suspended until the end of 2022, it is the ideal opportunity to do so ”.
“A credible response to this problem – continued the President of the Council – would improve the capacity of the euro area to respond to crises and at the same time further strengthen the independence of the ECB. An expansionary fiscal policy is not in contrast with the gradual decline in the ratio of debt to gross domestic product necessary in the medium term to reduce the fragility of an overexposure. However, we need to look up from the macroeconomic horizon to reflect on the profound transformation that our societies are preparing to face. The energy transition, the awareness of the importance of research and the path that will lead future generations towards the objectives of 2030 and 2050 give the state an active role that is crucial. Not only in the construction of key infrastructures in research and development. But above all in catalyzing private investment in priority areas. By giving confidence. Simplifying the procedures. Helping businesses manage risk in new areas. By designing transparent decarbonization policies shared between countries ”.
Finally, in view of the arrival of funds from the next Next Generation EU approval of the PNRR by the European Commission, the premier remarked that “for Italy, this is a favorable moment”.
“The certainties provided by Europe and the choices of the government – he concluded – the ability to overcome some of what were considered identity barriers, the abundance of public and private financial means are exceptional circumstances for businesses and households who will invest capital and savings in technology, training, modernization. But it is also the right moment to combine efficiency with equity, growth with sustainability, technology with employment. It is a moment in which the taste of the future prevails. Let’s live it fully, with determination and solidarity ”.