Research project TA/00/39 (Research action TA)
Since the onset of the sovereign debt crisis in Europe, developments in public debt of Euro zone countries have been closely followed up by financial markets. Belgium, one of the countries in Europe with the highest level of debt relative to GDP, has not been an exception. Even though Belgium has managed to stay more or less off the radar screen of international investors thanks to its economic performance, the on-going political crisis and the uncertainty surrounding the potential effects of future reforms have attracted, more recently, the attention of market participants as spreads on government bonds have been widening. This pushed the question of debt sustainability to the top of the agenda of Belgium’s policy- makers.
The standard approach to debt sustainability assessment consists in analysing the relative behaviour of the two main variables influencing debt dynamics, namely the cost of refinancing debt and the growth rate of the economy. An extensive literature exists on this topic, but most of it is concerned about the long term, average, values of interest and growth rates and tends to neglect the uncertainty surrounding these and in particular determinants of the cost of refinancing debt. The sovereign debt crisis in the Euro zone has shown that the cost of refinancing debt is uncertain and that it may be subject to rapid changes which can have very costly effects even if the long-term sustainability of the country under consideration seems unquestioned.
Accordingly, the central objective of this research project will be to present an overall analysis of Belgium’s debt sustainability accounting for the factors of risk that could affect the cost of refinancing its debt in the future. For this purpose the analysis will focus on sources of uncertainty associated with long-term trends and relevant institutional reforms. In particular considerable attention will be devoted to i) the effects of an ageing population, ii) developments in households’ savings and iii) the possible consequences of reforms aiming at fiscal federalism.
To achieve its central objective, the project will develop around two lines of research, each of them with a distinct sub-objective.
First, the analysis of ageing population: The impact of ageing on public finances will be addressed with particular emphasis on regional differences (an aspect which will also be related to the second line of research) and on implicit liabilities. But also another dimension which goes beyond the direct effects of ageing on public spending will be investigated: the links between demographic transition and savings. This analysis will aim at identifying the state of the demographic transition in Belgium, its potential effects on households’ savings and on debt sustainability through its impact on the risk premium. There is some evidence, suggesting that countries with persistent and large current account deficits, and hence low propensity to save, tend to experience swift increases in the cost of refinancing in the international financial markets. Since demographic transition affects savings, the future evolution of the demographic profile of Belgium could contribute either to making it easier to finance deficits and sustain a high level of debt, through higher domestic savings, or on the contrary, contribute to making it more difficult.
Second, the study of possible reforms aiming at fiscal federalism, not only considering its effects on regions and communities, but also on the federal state and on the federal debt, intends to increase the understanding about the possible meaning of a major fiscal change in Belgium for its European obligations (Stability and Growth Pact) and for the sustainability of the existing stock of government debt. The latter aspect will be carefully investigated by modeling the Special Finance Act for Regions and Communities in a flexible framework that can be adapted to integrate new proposals. The team will also contribute to the elaboration of alternative financing options for the regions based on empirical estimates of contagion mechanisms among regions and taking into account fiscal competition among regions.
Belgian debt sustainability: regional, federal and European perspectives (BELDEBT) : final report
Alcidi, Cinzia - Artige, Lionel - Busse, Mthias ... et al Brussels : Belgian Scientific Policy, 2015 (SP2632)
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