Government Debt Sustainability in The Age of Fiscal Activism

JPMorgan Chase Bank, New York
Economic Research
June 11, 2010
Government debt sustainability in the age

of fiscal activism
• Developed market fiscal positions deteriorated by a massive 6.2%-pts of GDP
between 2007 and 2010, while net debt skyrocketed almost 20%-pts of GDP, re-
flecting the depth of the recession in a world of increased fiscal activism and depen-
dence on asset prices for revenues.
• If solid growth is sustained, significant fiscal consolidation lies ahead. Fiscal
imbalances will be halved by 2013, lowering deficits to 4% of GDP.
• Still, this large adjustment will leave deficits at elevated levels and not deliver
debt sustainability. Our projected fiscal adjustment falls 2%-points of GDP
short of achieving stable debt positions by the end of our forecast horizon in
2013. In the long run, increases in entitlement spending, which are estimated to
rise by 7.6% of GDP from 2010-2050, pose a daunting fiscal challenge.
• Japan is furthest from achieving sustainability by 2013 due to its high debt and
low nominal GDP growth. The US will be much closer given its better nominal
growth outlook, but still fall short. The relatively small fiscal footprints of the
US and Japan afford opportunities to correct imbalances by raising revenues.
• Among the G-3, the Euro area will stand closest to debt sustainability in 2013.
However, the size of its fiscal footprint limits options to complete the adjustment.
Also, poor demographics and generous entitlement schemes indicate that underly-
ing fiscal pressures are the greatest.
• Euro area aggregates mask wide variation in the region. Greece, Ireland, and
Italy will remain the furthest from debt sustainability despite current consolida-
tion plans; Spain is much closer, but also falls short. Peripheral European
economies face the most pressures from aging and entitlement spending.
• Outside the G-3 economies, fiscal conditions are much better. This group com-
prises the commodity producing nations of Australia, New Zealand, Norway,
and Canada, but also includes Sweden and Switzerland. While none escaped
large fiscal deteriorations during the downturn, their strong initial conditions
(net lending surpluses and low debt) make debt sustainability much easier.
• The fiscal challenges go beyond the arithmetic of debt sustainability. If consoli-
dation is achieved by increasing the scale of government, losses in efficiency
could outweigh any revenue gains.
Primary surplus, 2013: Required for debt sustainability and J.P. Morgan forecast
J.P. Morgan fcst (% of GDP) Joseph Lupton
Surpasses sustainability by 2013 (1-212) 834-5735
4 45 degree line
PRT joseph.p.lupton@jpmorgan.com
3
2 SWE DEU
CAN AUT
1 GBR GRC
CHE David Hensley
AUS EUR ITA
0 FRA (1-212) 834-5516
ESP
-1 USA BEL david.hensley@jpmorgan.com
NLD DM Falls short of sustainability by 2013
-2 NZL
-3
IRL
-4
JPN
-5
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
Required for debt sustainability (% of GDP) www.morganmarkets.com
JPMorgan Chase Bank, New York Economic Research
Joseph Lupton (1-212) 834-5735 Government debt sustainability in the age of fiscal activism
joseph.p.lupton@jpmorgan.com June 11, 2010
David Hensley (1-212) 834-5516
david.hensley@jpmorgan.com
Contents: Page Government debt sustainability in the age of fiscal activism

Debt sustainability in an age of
fiscal activism 2 Any retrospective of the global financial crisis will no doubt give some credit to
The anatomy of a fiscal blowout 4 unprecedented government action as a key ingredient to preventing a far worse out-
Fiscal balances have become more procyclical 8 come. In the developed markets (DM), discretionary fiscal stimulus packages alone
Largest fiscal consolidation in over 40 years 11
amounted to almost 4% of GDP between 2008 and 2010, or about 1.3% per year for
A framework for assessing debt sustainability 15
Debt sustainability by 2013 unlikely 18 three years. Combined with significant automatic stabilizers, the public sector pro-
Beyond the arithmetic of fiscal sustainability 25 vided a huge support to aggregate demand in the face of widespread deleveraging
in the private sector. At the same time, these actions have not come cheaply. As the
economic recession spread around the world, fiscal revenues in the DM fell outright
between 2007 and 2009 even as outlays jumped. On net, the fiscal lending position
of the DM as a share of GDP fell sharply by more than 6%-points to a post-World
War II low of -8.0% in 2009, with little change expected for 2010. As a result, net
debt of the public sector has skyrocketed from 43% of GDP in 2007 to 62% in
Fiscal supports during the crisis have
added 20%-points to the developed
2010.
market debt-GDP ratio
The primary force driving fiscal positions to extremes was the deep recession, which
had significant automatic effects on social spending and income-sensitive tax rev-
enues. However, the massive deterioration in fiscal positions also reflects a number of
secular forces that have been on the rise over at least the past two decades:
• Rise of fiscal activism. There has been a general rise in the degree to which gov-
ernment officials have responded to cyclical downturns with countercyclical poli-
cies. The last three recessions were cushioned in a more timely and aggressive
The fiscal response reflects the depth manner than prior downturns. Although this support to aggregate demand un-
of the downturn against a backdrop doubtedly minimized the depth of the fall in economic activity, it has also left a
of secular forces that have increased
lasting imprint in the form of increasing fiscal debt.
fiscal sensitivities to the cycle
• Fiscal revenues’ increased dependence on asset prices. Broadly speaking, the
last two decades have witnessed two periods of sharp asset price appreciation that
were both followed by collapse. The large capital gains and subsequent capital
losses associated with equities and housing amplified the inherent procyclicality
of fiscal revenues. Relying on these large windfalls allowed governments to be-
come lax in dealing with underlying structural deficits that have been made bla-
tant with the 2008-09 asset price bust.
Fiscal deficit and gross debt, developed markets

% of GDP; both scales (J.P. Morgan fcst 2010-13)
10 120
Debt
8
100
Deficit
6
80
4
60
2
40
0
-2 20
60 65 70 75 80 85 90 95 00 05 10
2
Joseph Lupton (1-212) 834-5735 Global Issues
Metrics of fiscal debt sustainability

% of GDP; changes are %-points of GDP
Net Debt Change in Net Lending Net lending, 2013 Chg Int Pymt Chg Entitlement Costs Revenues
2007 2013 2007 to 2010 2010 to 2013 JPM fcst Debt sustainability 2007 to 2016 2010 to 2050 2007
Developed markets 42.7 69.3 -6.2 3.7 -4.0 -1.9 1.0 7.6 38.7
US 42.3 74.2 -7.0 5.2 -4.5 -2.6 1.7 7.0 34.0
Japan 80.4 128.6 -5.0 -0.9 -8.4 -0.8 1.1 7.1 33.5
UK 28.8 58.4 -7.2 7.4 -2.2 -2.0 1.4 7.2 41.4
Euro area 43.1 63.1 -6.0 3.3 -3.4 -2.1 0.4 8.9 45.4
Germany 42.9 56.3 -5.8 4.3 -1.2 -1.2 0.0 7.5 43.8
France 34.0 67.4 -5.5 4.7 -3.5 -2.2 0.7 7.3 49.6
Italy 87.1 99.3 -3.2 -0.3 -5.0 -2.6 1.0 7.0 46.4
Spain 18.7 55.5 -11.5 5.8 -3.7 -2.4 1.6 13.5 41.1
Greece 70.4 126.3 -2.6 1.4 -6.3 -3.5 4.1 16.8 40.4
Ireland -0.3 63.5 -11.6 3.8 -7.7 -3.1 3.1 14.4 36.5
Portugal 44.1 63.7 -4.5 7.5 0.3 -2.7 0.2 15.5 43.2
• A bigger fiscal footprint. The share of the public sector in overall economic ac-
tivity has steadily drifted higher over the past 40 years. Outlays vaulted higher in
the 1970s and then were fairly stable thereafter (especially excluding interest
payments). The total funding needs of the government have grown from 34% of
GDP in 1970 to 45% in 2009. The revenue share of GDP rose almost continu-
ously but always remained below the expenditure share. The upshot is that DM
budgets were in chronic deficit despite the benefit of falling interest rates. With
revenues falling short, net debt of the public sector has moved up from just 19%
of GDP in 1970 to over 60% as of this year.
Just as asset price declines and greater fiscal activism contributed to the sharp deterio-
ration in public finances during 2008-10, they are now poised to lever the improve-
ment in budget positions in the expansion. Provided the global expansion continues to
Largest fiscal consolidation in over
40 years is now in the offing deliver solid growth, the largest fiscal consolidation in over 40 years is in the offing
for the developed world. What is unique about this situation is that while many coun-
tries have attempted comparable adjustments individually, never has the collective
engaged in a synchronized tightening of fiscal policy of this magnitude. The improve-
ment will reflect the unwinding of large fiscal stimulus packages. It also will reflect
the fading of automatic stabilizers, consistent with J.P. Morgan’s forecasts for real GDP,
inflation, and government borrowing rates through 2013. In all, fiscal deficits are ex-
pected to be cut in half in the coming few years, falling to about 4% of GDP by the
end of our forecast horizon in 2013.
Progress in putting fiscal conditions on sounder footing will ultimately be judged

against the backdrop of debt sustainability. The framework for assessing
sustainability developed here suggests that the outlook is problematic. Taking into
account the projected fiscal adjustment through 2013, along with our estimates of
potential growth and market forward rates for borrowing costs thereafter, debt
Debt sustainability will not be
sustainability is unlikely to be achieved in the developed world by 2013. Thus debt
achieved by 2013 for most DM levels will continue to rise in most countries until the middle of the decade at the
governments earliest. Japan is likely to stand furthest from achieving sustainability. Among the
G-3, the Euro area is likely to come closest to stabilizing debt positions in 2013.
However, this represents the aggregate position of the region and incorporates full
implementation of fiscal consolidation plans on the periphery. Within the periphery,
Portugal is projected to more than achieve debt sustainability, while Spain will get
close. By contrast, Greece, Ireland and Italy are likely to see debt continue to rise at
a brisk pace beyond our forecast horizon of 2013.
A number of headwinds will make implementing such a large region-wide fiscal

adjustment a serious challenge. First, the outlook for growth does not foresee a re-
3
turn of unemployment rates to their pre-recession levels. This slow return to nor-
A modest recovery relative to the malcy will damp revenue growth while also keeping outlays elevated. At the same
depth of the downturn along with
time, government borrowing rates will likely be moving higher in coming years,
increasing interest rates raise the
hurdle for debt sustainability reversing a 15-year downtrend. Combined with the huge increase in outstanding
debt, interest payments as a share of GDP are expected to move up by 1.4%-points
between 2007 and 2016 in the DM, with Japan, Greece, and Ireland seeing 3-4%-
point increases.
Additional headwinds exist but are more difficult to quantify. These forces bear
heavily on a nation’s willingness and ability to make fiscal adjustments. The aging of
the population is one parameter that will affect all developed countries in the coming
two decades. Absent material reforms, the resulting ballooning of entitlement costs
over the next 40 years is seemingly insurmountable for all countries. As in the case of
the sustainability arithmetic, the countries on the periphery of the Euro area are facing
the biggest challenges.
Aging populations point to consider-
able fiscal challenges well beyond Countries with a relatively small public sector would also appear to have greater
this decade flexibility for adjustment as experience suggests it is easier to raise revenues than
reduce spending. In this case, core Europe faces the largest hurdle. Indeed, Japan
and the US have the option of becoming core Europe in terms of fiscal structure as
a means of correcting fiscal imbalances. Of course, increasing the fiscal footprint
has its own risks. In addition to reducing fiscal flexibility in the event of another
significant downturn, higher government involvement in economic activity risks
damping productivity and overall potential growth.
The anatomy of a fiscal blowout

The policy response to the global financial crisis was large and broadly based.
Policy interest rates were pushed down to historic lows in most large economies,
and many central banks engaged in unconventional measures to support financial
stability. There was also widespread support provided to financial firms, and major
fiscal stimulus programs were implemented. Although these measures were impor-
Net lending position of the general government
% of GDP; J.P. Morgan forecast for 2010 and 2013
2007 2008 2009 2010 2013
Developed markets -1.5 -3.7 -8.0 -7.7 -4.0
US -2.8 -6.5 -10.8 -9.8 -4.5
Japan -2.5 -2.7 -6.8 -7.5 -8.4
Euro Area -0.6 -2.0 -6.3 -6.6 -3.4
Germany 0.2 0.0 -3.3 -5.6 -1.2
France -2.7 -3.3 -7.5 -8.2 -3.5
Italy -1.5 -2.7 -5.3 -4.7 -5.0
Spain 1.9 -4.1 -11.2 -9.6 -3.7
Netherlands 0.2 0.7 -5.3 -6.6 -4.8
Belgium -0.2 -1.2 -6.0 -4.1 -4.1
Austria -0.4 -0.4 -3.4 -4.5 -2.1
Greece -5.1 -7.7 -13.6 -7.7 -6.3
Ireland 0.1 -7.3 -14.3 -11.5 -7.7
Portugal -2.6 -2.8 -9.4 -7.1 0.3
UK -2.4 -6.0 -11.1 -9.6 -2.2
Norway 17.7 18.8 9.5 11.1 14.2
Sweden 3.8 2.5 -1.1 -1.3 1.6
Switzerland 1.6 1.6 -0.7 -1.3 0.4
New Zealand 5.0 3.1 -2.2 -3.8 -1.7
Australia 1.8 1.0 -2.1 -4.3 0.3
Canada 1.6 0.1 -3.6 -2.8 -0.3
Note: The net lending position is the difference between total receipts and total outlays. Its negative is what is commonly called "the
government deficit." Here, the measure is for general government—federal, state, and local.
4
Discretionary fiscal stimulus during the crisis

In addition to the support to aggregate demand from automatic stabilizers, which in-
clude reduced income taxes and social insurance spending, governments around the
world enacted a tremendous amount of discretionary stimulus. Based on a recent
OECD report, discretionary stimulus of the central governments from 2008 to 2010
amounted to about 4% of 2008 GDP for the developed markets as a whole, or 1.3%-
pt of GDP per year. The composition of this stimulus was broad-based, although
households were the largest beneficiaries, receiving roughly 60% of the total stimulus
in contrast to only 30% accruing to businesses. The remaining 10% reflects transfers
from the central government to state and local municipalities. Excluding these trans-
fers, the split between tax relief and spending measures was about 50-50.
As reported by the OECD, the magnitude and composition of the stimulus measures
vary by country. Stimulus in the US amounted to 5.6% of 2008 GDP and was mostly
concentrated in tax and spending measures devoted to households. Indeed, at 20%,
only Greek and Swiss businesses received smaller shares of the total stimulus pack-
age than those in the US. Australia and Japan also stand out but the measures there
were directed toward businesses. For the Euro area as a whole, stimulus was mostly
spread between tax relief to households and spending measures directed toward busi-
nesses, mostly reflecting the stimulus mix in Germany, Spain, and the Netherlands.
The overall magnitude of the stimulus measures in France and Italy was notably
smaller than in the rest of the region and the developed economies.
Fiscal stimulus spending of the central (federal) government, 2008 to 2010
% of 2008 GDP
6
Intra-govt transfer
5
Spending: Business
4
Spending: Household
3 Tax: Business
2 Tax: Household
-1
JPN
USA
AUS
ESP
SWE
FRA
ITA
CHE
NZL
BEL
DM
CAN
DEU
NLD
GBR
EUR
NOR
GRC
AUT
Source: OECD Economic Outlook, May 2010; J.P. Morgan
tant in arresting the global economic downturn, the recession produced larger out-
put losses than any downturn in over 50 years. This combination of a deep reces-
sion and an active policy response has produced considerable damage to fiscal posi-
tions across the developed world.
For the developed markets as a whole, the net lending position of the general gov-
ernment, which includes state and local municipalities, fell from -1.5% of GDP in
2007 to -8.0% in 2009. This post-World War II high will likely be maintained in
2010. Outcomes varied widely across the region. The largest deterioration between
2007 and 2010 has been in Ireland and Spain, with net lending plunging close to
12%-points of GDP. Provided Greece and Portugal are able to implement their ag-
5
gressive fiscal consolidation plans this year, the overall deterioration in net lend-
ing positions between 2007 and 2010 will have been below the developed market
average but still significant. By contrast, with little fiscal consolidation planned for
this year in the US or the UK, the deterioration over the past three years will remain
considerable at about 7%-points of GDP.
Decomposing the deterioration into cyclical and structural components highlights

how countercyclical fiscal policy varies by country. In general, fiscal policy cush-
ions economic downturns through two channels. The first is by way of automatic
stabilizers. These cyclical measures are built into the existing institutional frame-
Automatic stabilizers were more work, so that government expenditures or receipts automatically increase or de-
important across Europe, while US crease over the business cycle without requiring government action. Automatic sta-
and Japan saw a larger relative rise bilizers include unemployment compensation and decreased corporate and indi-
in the structural deficit vidual income tax payments. Based on OECD estimates (combined with our own
forecasts), cyclical lending positions during the downturn moved in line with his-
torical norms given the decline in GDP. In general, automatic stabilizers play a
larger role in European fiscal policy. Accordingly, the fall in cyclical lending posi-
tions comprised the majority of the total deterioration in net lending in almost every
Western European economy. By contrast, the share was closer to 25% outside this
region, including in the US and Japan.
The second channel by which fiscal policy is implemented is through the launching of
new spending and tax initiatives to boost aggregate demand. Such fiscal stimulus
measures include discretionary changes in government expenditures and modifica-
tions to the tax code (or one-time income rebates or transfers). These changes are de-
fined as structural. Not surprisingly, changes in the structural deficit made up a larger
share of the deterioration in net lending in most of the economies outside of Europe,
particularly in the US and Japan. Combined, the structural and cyclical lending posi-
tions make up the “primary” lending position. Subtracting net interest payments on
existing debt from the primary surplus yields the total net lending position.
Fiscal deterioration reflected a rise in This sharp deterioration in fiscal positions reflects the combination of an accelera-
outlays..... tion in outlays and a rare outright decline in revenues. A simple average across the
developed markets shows general government outlays rose at a 4.7% annualized
pace from 2004 to 2007. Outlays then accelerated to a 5.9% pace in 2008 and 2009.
The largest acceleration in outlays over this period occurred in Greece, where
spending growth rose from 6.8% in the pre-crisis period to a 10.9% pace during the
Change in net lending position, 2007 to 2010
%-points of GDP; dot shows total change (2010 J.P. Morgan forecast)
-2
-4
-6
-8 Interest
Cyclical
-10 Structural
-12
JPN
ESP
USA
AUS
FRA
SWE
ITA
CHE
IRL
NZL
BEL
DM
GBR
NLD
NOR
EUR
DEU
CAN
PRT
AUT
GRC
6
General government outlays General government revenues

%change, annual rate; sorted by change in growth rate %change, annual rate; sorted by change in growth rate
12 12
2004-2007
10 9
2008-2009
8 6
6 3
4 0
2 2004-2007 -3
2008-2009
(Note: IRL 2008-09 = -12.4%)
0 -6
JPN
ESP
USA
AUS
FRA
SWE
ITA
CHE
IRL
NZL
BEL
DM
DM
GRC
JPN
DEU
FIN
NOR
GBR
NLD
EUR
CAN
NOR
GBR
CAN
GRC
EUR
FIN
NLD
DEU
PRT
AUT
AUT
CHE
AUS
SWE
USA
ESP
ITA
FRA
BEL
NZL
crisis. Japan and Germany also saw a large acceleration, while the Euro area as a
whole posted a relatively modest acceleration, anchored by a stable rate of growth
in France, Italy, and Spain. Outlays in the US also accelerated modestly, from an
already rapid pace heading into the financial crisis. Overall, a combination of rising
spending and falling output has pushed fiscal expenses to over 43% of developed
world GDP, a level roughly 5%-pts higher than in 2007.
...and a rare outright decline in The downshift in revenues during the recession was perhaps more striking than the
revenues acceleration in outlays. Overall revenues fell 4% from 2007 to 2009, only the third
outright decline in the past 40 years and by far the largest. The sharp downshift in
revenues during the crisis is a broad-based pattern seen across the developed world.
The largest swing occurred in Ireland, where revenues were rising at a 10.2% annual-
ized pace from 2004 to 2007 before collapsing at a 12.4% pace in 2008 and 2009.
Very large swings also occurred in the US, the UK, Spain, Canada, and New Zealand.
In general, these sharp swings are most evident in countries that experienced declin-
ing economic activity alongside a plunge in equity and house prices.
In response to the widespread and large declines in net lending positions, public
After rising 24%-points of GDP from
1970 to 2007, fiscal net debt of the sector debt has surged. Prior to the downturn, net financial liabilities (net debt) in
DM surged 13%-points in 2008 and the developed markets rose from 18.9% of GDP in 1970 to 42.7% in 2007. Of this
2009. 23.7%-point rise, total net borrowing added 103%-points, with interest payments
contributing the overwhelming majority and the primary deficit (on net) adding just
17%-points. Increases in nominal activity reduced net debt as a ratio to GDP. In
whole, GDP growth subtracted 72%-points from the change in the net debt ratio
from 1970 to 2007, split about equally between real growth and inflation.
Change in net liabilities, developed markets

%-point of GDP (J.P. Morgan forecast 2010-2013)
1971 to 1980 1981 to 1990 1991 to 2000 2000 to 2007 1971 to 2007 2008 to 2009 2010 to 2013
Change in net debt 0.8 11.6 8.4 3.0 23.7 13.2 13.5
Contributions from:
Net borrowing (deficit) 17.3 37.1 30.5 19.4 104.2 12.2 22.2
Net interest 11.7 28.8 32.0 14.7 87.3 4.0 9.5
Primary deficit 5.5 8.2 -1.6 4.7 16.9 8.2 12.6
GDP growth, real -6.9 -10.5 -10.7 -6.5 -34.7 1.5 -6.0
GDP inflation -14.5 -11.6 -8.2 -6.1 -40.5 -1.2 -2.9
Residual 5.0 -3.4 -3.2 -3.6 -5.2 0.6 0.2
Note. Residuals reflect one-off balance sheet adjustments unrelated to net lending, aggregation errors, as well as measurement errors.
7
Debt of the general government

% of GDP; J.P. Morgan forecast for 2010 and 2013
Net financial liabilities Gross financial liabilities
2007 2010 2013 2007 2010 2013
Developed markets 42.7 61.7 69.3 75.4 97.7 106.1
US 42.3 64.1 74.2 61.8 88.2 97.5
Japan 80.4 103.5 128.6 167.1 194.7 218.5
Euro Area 43.1 58.8 63.1 66.0 83.7 88.0
Germany 42.9 55.7 56.3 65.0 76.7 77.3
France 34.0 60.5 67.4 63.8 83.7 90.5
Italy 87.1 101.2 99.3 103.5 117.7 115.8
Spain 18.7 45.2 55.5 36.2 62.1 72.4
Netherlands 28.0 33.1 42.4 45.5 66.1 75.3
Belgium 73.4 82.3 81.9 84.2 98.0 97.6
Austria 30.7 39.9 40.9 59.5 69.7 70.8
Greece 70.4 107.6 126.3 95.7 132.9 151.6
Ireland -0.3 44.7 63.5 25.0 77.2 96.1
Portugal 44.1 64.3 63.7 63.6 82.7 82.2
UK 28.8 52.9 58.4 46.9 77.9 83.9
Norway -142.5 -128.7 -151.5 58.4 59.0 45.2
Sweden -25.0 -13.5 -14.3 47.9 48.8 45.7
Switzerland 11.0 10.3 9.9 47.2 44.3 42.6
New Zealand -13.2 -8.3 -0.1 26.2 30.2 36.6
Australia -6.3 -0.1 2.2 15.3 19.5 20.7
Canada 23.1 28.0 27.3 65.0 74.3 71.5
Since the onset of the economic downturn in 2008, net debt of the developed econo-
mies has jumped 13.2%-points of GDP through 2009 and is projected to rise another
13.5%-points in 2010 to 2013, with net debt reaching 69.3% of GDP. Of this almost
30%-point rise in just six years, 22%-points owe directly to primary deficits, with
interest payments accounting for most of the rest against a backdrop of relatively
modest nominal GDP growth.
The rise in debt from 2007 to 2010 has been relatively broad-based across the major
developed economies, with the US, Japan and the UK seeing a roughly 20%-point
rise and the Euro area seeing a 16%-point rise. However, developments within the
Euro area vary widely. The northern European economies, along with Italy, have seen
relatively modest increases in net debt of between 5 and 15%-points. By contrast, net
debt has moved up between 20 and 30%-points in France, Spain, and Portugal, and has
soared in Greece and Ireland by roughly 40%-points.
Fiscal balances have become more procyclical

Despite the striking deterioration of fiscal positions, the moves have largely been
consistent with a secular rise in the cyclicality of fiscal policy. In the 1970s and
The deterioration in government 1980s, a 1%-pt fall in the DM output gap was accompanied by a 0.5% of GDP de-
finances was amplified by a secular cline in the net lending position, on average. The magnitude of this response
rise in the cyclicality of fiscal lending doubled in the 1990s and 2000s, to somewhat greater than 1% of GDP. This higher
positions
“beta” between the business cycle and fiscal policy held during the latest recession.
The DM output gap fell from 1.3% of GDP in 2007 to -4.6% of GDP in 2009. Over
the same period, the DM budget balance declined from -1.5% of GDP to -8.0% of
GDP. The ratio of these moves is 1.1, in line with the past two decades’ experience.
The increased cyclicality of the primary lending position owes entirely to the struc-
tural primary lending position. As computed by the OECD, the cyclical balance re-
flects a subset of revenues and outlays (apart from interest receipts and payments)
that move with the business cycle. Thus, by construction, the cyclical component of
the DM primary deficit correlates almost perfectly with the output gap and is inter-
preted as reflecting the automatic stabilizer channel of fiscal policy. The structural
8
budget balance is the portion of the primary balance that is left after removing the
The rise in fiscal cyclicality owes to cyclical balance. The connection between the output gap and the structural budget
an increased correlation and “beta” balance is much looser. Since the direct effect of the business cycle on revenue and
of structural lending positions expenditure is supposed to be captured in the cyclical balance, what is left over is
deemed structural and thus “independent” of the cycle.
The OECD estimates of the cyclical and structural balances for the DM economies
illustrate these points. The relationship between the output gap and the cyclical bal-
ance has been remarkably stable over the past 40 years for the DM as a whole and
across the major DM economies, where the correlation is close to -1. On average, a
1% fall in DM output relative to potential results in a rise in the cyclical primary
deficit of 0.3% of GDP. As expected, the correlation between the output gap and
the structural balance in the 1970s and 1980s was loose and unstable. However, the
fit tightened in the 1990s and beyond, as the structural balance—like its cyclical
complement—became consistently more cyclical. Moreover, the structural balance
became higher beta during this period, displaying an increased amplitude with re-
spect to the business cycle.
The tighter gearing of the structural balance with the economy reflects several fac-
tors. First is the increasing activism of DM governments with respect to the busi-
ness cycle. In recent decades, governments have developed a tendency to conduct
The rise in structural cyclicality countercyclical fiscal policy to damp the business cycle. This behavioral shift was
reflects increased fiscal activism and
a greater dependence on asset price
highly visible during the current downturn, when governments across the globe
cycles boosted spending or cut taxes to support their economies. To the extent that this
behavior becomes routine, it will boost the correlation of the structural balance with
the business cycle.
In addition to discretionary fiscal policy, asset price movements have boosted the
cyclicality of the structural balance. Equity prices displayed a boom-bust pattern in
the 1990s and 2000s, whereby prices boomed during the economic expansion fol-
lowed by a crash during the recession. The effect of this pattern is only partially
captured in OECD estimates of the cyclical balance, which is limited to standard
sources of revenue including taxes on wage income, corporate income, and sales, as
well as spending on unemployment insurance. For example, higher sales tax re-
ceipts resulting from a positive consumer wealth effect would be captured in the
cyclical balance, but tax revenues from realized capital gains would not. Instead,
Cyclical primary balance and the output gap, dev. markets Structural primary balance and the output gap, dev. markets
%, GDP relative to potential %-points of GDP %, GDP relative to potential %-points of GDP
4 1.5 4 Output gap 4

Output gap
1.0
2 2 2
0.5
0 0 0
0.0
-0.5
-2 -2 -2
Cyclical primary
balance -1.0 Structural primary
-4 -4 balance -4
-1.5
-6 -2.0 -6 -6
70 75 80 85 90 95 00 05 10 70 75 80 85 90 95 00 05 10
9
Cyclicality of primary balance, developed markets Primary balance response to cycle, developed markets
Correlation with output gap, 10-yr backward-rolling %-pt of GDP, change given 1%-pt change in output gap,
Cyclical 10-yr backward-rolling beta
1.0
0.8 2.0
0.6 Total Total
0.4 1.5
0.2
1.0
Structural
0.0
-0.2 0.5
Structural Cyclical
-0.4
0.0
-0.6
-0.8 -0.5
80 84 89 94 00 04 09 80 84 89 94 00 04 09
the capital gains tax revenue would be counted toward the structural balance. A re-
duction in government pension contributions due to the surge in equity prices also
would count toward the structural balance.
Both outlays and revenues have Regression analysis demonstrates this evolution in the nature of the structural bal-
increased in cyclicality over the past ance and its contribution toward the more high-beta nature of government activity.
few decades
The regressions, which cover the period from 1970 to 2007, test the sensitivity of
net lending to the output gap and whether this sensitivity has changed over time. In
doing so, they also control for movements in asset prices. The results confirm that
the net lending became more sensitive to swings in equity prices as these swings
became larger and more correlated with economic activity in the 1990s and 2000s.
In contrast, we found little correspondence between movements in house prices and
budget balances. The regressions also show that the sensitivity of the budget bal-
ance to the business cycle has approximately doubled, even after controlling for
equity prices, since the early 1990s. This reflects the increased activism of govern-
ments seeking to damp the business cycle.
Net lending sensitivity to the cycle and asset prices
Regression of change in net lending on change in output gap and asset price growth, sample 1970-2007
Aggregate Regression Panel Regression
i ii iii i ii iii
Constant -0.06 -0.10 -0.18 0.00 -0.05 -0.22
(-0.48) (-0.95) (-2.50) (-2.50) (-2.50) (-2.50)
Change in output gap 0.57 0.48 0.48 0.51 0.41 0.40
(5.79) (4.54) (4.42) (4.42) (4.42) (4.42)
Change in output gap*d(1993-2007) 0.67 0.49 0.57 0.47
(2.46) (3.64) (-0.99) (3.64)
Equity price appreciation -0.01 0.00
(-0.99) (-0.99)
Equity price appreciation*d(1993-2007) 0.04 0.04
(3.51) (3.51)
Adjusted R-squared 0.49 0.56 0.65 0.65 0.65 0.65
Note. Two sets of regressions are examined. The first estimates simple regressions using developed market aggregates (computed as GDP-
weighted averages). The second set uses country level data to estimate a panel regression, where each country implicitly receives an equal weight.
The panel regression includes data for USA, EUR (GDP-weighted average), JPN, GBR, SWE, AUS, CAN, NOR. In both sets of regressions, models
ii and iii highlight how the coefficients on the two variables of interest (output gap and equity prices) have changed between the 1970 to 1992 period
and the 1993 to 2007 period. This change is shown by the coefficient on the variable of interest interacted with a dummy variable that equals 0 in the
former period and 1 in the latter period. The total effect in the 1993 to 2007 period is found by adding the two respective coefficients. Bold values are
statistically significant at all standard levels of significance. Standard errors are corrected for serial correlation. Historical asset price data are
from recent OECD research, "Fiscal policy reaction to the cycle in the OECD: Pro- or counter-cyclical?" (OECD WP#763, Balázs Égert).
10
Fiscal policy's relationship to the business cycle

Correlation with respect to the output gap; Beta is response (% of GDP) to 1%-pt chg in the output gap
Net lending Revenues Outlays
Pre '93 Post '93 Change Pre '93 Post '93 Change Pre '93 Post '93 Change
------------------------------------------------- Correlation -------------------------------------------------
Developed markets 0.55 0.87 0.32 -0.11 0.45 0.57 -0.37 -0.83 -0.47
US 0.55 0.66 0.11 0.14 0.50 0.36 -0.36 -0.66 -0.31
Euro Area 0.49 0.81 0.32 -0.52 -0.27 0.25 -0.55 -0.82 -0.27
Japan 0.55 0.67 0.12 0.15 0.41 0.26 -0.19 -0.63 -0.44
UK 0.33 0.64 0.31 -0.55 0.85 1.40 -0.60 -0.31 0.28
Norway 0.56 0.68 0.11 -0.03 0.48 0.51 -0.43 -0.75 -0.31
Sweden 0.61 0.91 0.30 -0.01 -0.36 -0.35 -0.35 -0.91 -0.56
Australia 0.70 0.80 0.11 -0.26 0.72 0.98 -0.48 -0.76 -0.28
Canada 0.42 0.86 0.43 -0.17 -0.51 -0.34 -0.33 -0.91 -0.57
---------------------------------------------------- Beta ----------------------------------------------------
Developed markets 0.53 1.49 0.97 -0.10 0.38 0.49 -0.63 -1.08 -0.45
U.S. 0.42 1.27 0.85 0.06 0.56 0.50 -0.36 -0.71 -0.34
Euro Area 0.68 1.34 0.66 -0.45 -0.17 0.28 -1.05 -1.47 -0.42
Japan 0.67 1.36 0.70 0.27 0.34 0.07 -0.39 -1.02 -0.63
U.K. 0.25 1.74 1.49 -0.43 1.00 1.44 -0.68 -0.71 -0.03
Norway 0.87 3.82 2.95 -0.03 0.92 0.95 -0.90 -2.92 -2.02
Sweden 1.31 1.79 0.48 -0.02 -0.42 -0.40 -1.32 -2.21 -0.89
Australia 0.66 2.26 1.60 -0.43 0.90 1.33 -1.08 -1.22 -0.14
Canada 0.49 1.59 1.10 -0.16 -0.42 -0.26 -0.66 -2.02 -1.36
Note. The beta on net lending need not equal the difference between the beta on revenues and the beta on outlays to the extent that the two
are correlated. Given that this difference is very close to the net lending beta in almost all cases underscores that revenues and outlays are
not highly correlated.
In addition to parsing the budget balance into its cyclical and structural components, a
decomposition into expenditures and revenues is also instructive. In this respect, the
DM fiscal beta relating the net lending as a percent of GDP to the output gap has
doubled from 0.53 in the 1970s and 1980s to 1.49 in the 1990s and 2000s.1 This
higher beta value reflects an outlay response of -1.08 and a revenue response of 0.38.
Both the outlay and the revenue responses increased in magnitude over the past two
decades. The increased beta on the expenditure side likely reflects increasingly active
countercyclical fiscal policy, whereby stimulus spending is enacted during economic
downturns. Stimulus measures such as temporary tax cuts or rebates help explain the
higher revenue response. In addition, the increased amplitude of the asset price cycle
and its impact on revenues has undoubtedly boosted the revenue beta.
The massive fiscal stimulus during The increased responsiveness of budget balances to the economic cycle is broadly
the financial crisis is not surprising based in the developed economies. The responsiveness of the net lending share of
given increased fiscal activism GDP has roughly doubled in each of the G-3 economies. Importantly, these esti-
mates do not include the most recent downturn. Consequently, the large fiscal re-
sponse to the global financial crisis, while striking, was entirely consistent with a
rise in fiscal activism and a greater reliance on revenues linked to the asset price
cycle. It was thus the depth of the downturn that triggered 1) a huge increase in au-
tomatic cyclical stimulus, 2) a sharp expansion in discretionary stimulus that was
consistent with the rise of fiscal activism over the past two decades, and 3) a plunge
in revenues associated with the collapse in equity and house prices.
Largest fiscal consolidation in over 40 years

The global recovery now under way is expected to set in motion the biggest fiscal
consolidation in the developed economies in over 40 years. The projected marked
improvement in DM budget balances is a function of the same three forces that pro-
duced such extreme deficits during the downturn.
1. This estimated beta of 1.49 for the post-1993 period is slightly larger than the 1.15 estimated in the DM regression from the previous
table. The difference is that the 1.49 beta is estimated over just the 1993 to 2007 period, while the 1.15 beta is estimated over the full
sample 1970 to 2007 with a dummy variable to capture the shift in the beta coefficient. The 1.15 beta is our preferred measure.
11
Change in the primary balance, developed markets

%-point of GDP, four-year changes; J.P. Morgan fcst 2010-2013
6.0
Structural
4.0
Total primary
2.0
0.0
-2.0
Cyclical
-4.0
-6.0
75 80 85 90 95 00 05 10
• The recovery will automatically reduce cyclical stimulus as the level of activity
The same forces that underlie the ramps up. Tax revenues will get a boost from increased personal and corporate
fiscal deterioration will produce the income. At the same time, expenditures on unemployment insurance and other
largest fiscal consolidation in over 40 social safety net programs will decline.
years
• The recovery will also generate an improvement in the underlying, structural
lending position. As discussed above, DM governments rolled out unprecedented
fiscal stimulus in the form of increased spending and tax cuts to support demand
during the downturn amounting to roughly 4% of GDP from 2008 to 2010. Gov-
ernments are now poised to begin withdrawing these extraordinary measures.
• Asset prices will also contribute to an improved fiscal picture. DM equity mar-
kets already have rallied from their early 2009 lows, but remain far below their
previous highs. Equity prices would be expected to recover further in coming years
if the DM economies experience a more extended period of solid growth, low core
inflation, and accommodative monetary policy, as we anticipate.
Change in primary surplus, 2008 to 2013

%-point of GDP (J.P. Morgan forecast 2010-13)
6 2011-2013
-3
-6
-9 2008-2010
-12
JPN
ESP
USA
FRA
AUS
SWE
CHE
ITA
IRL
NZL
BEL
DM
DEU
EUR
CAN
GRC
NOR
NLD
PRT
GBR
AUT
12
G-3 fiscal impetus from 2007 to 2013

%-point of GDP (negative change in primary surplus)
5
4
Cyclical
3
2
Structural
1
-1
-2
-3 ------------ USA ------------ ------------ EUR ------------ ------------ JPN ------------

07 08 09 10 11 12 13 07 08 09 10 11 12 13 07 08 09 10 11 12 13
The anticipated tightening of fiscal positions is expected to damp GDP growth begin-
ning in 2011 but not stifle it. The improvement in the cyclical deficit will be dictated
by the pace of the economic recovery and so does not constitute fiscal tightening. The
withdrawal of discretionary fiscal stimulus does. However, the extraordinary policy
The coming fiscal consolidation will
damp but not stifle the recovery stimulus put in place in 2008 and 2009 sparked a recovery in financial markets, confi-
dence, and consumer spending. Businesses are now responding with a shift from cost
cutting to broad-based expansion, including increased spending on capital and labor.
With labor income accelerating and asset prices recovering, consumers will have the
fundamental support they need to allow governments to withdraw support gradually.
In addition, monetary policy is expected to remain highly accommodative amid
record-low G-3 core inflation.
Against this backdrop, the primary balance in the developed markets is projected to
rise from -6.3% of GDP in 2009 to -1.2% in 2013. This 5.1%-point improvement, if
achieved, would mark the largest four-year increase in over 40 years on the heels of
the largest decline. Although the cyclical balance will make a significant contribu-
tion to this move, reflecting the improvement in the economy, the lion’s share of
the adjustment will reflect active belt-tightening in the structural balance.
Change in the primary balance 2010-2013 Change in the structural primary balance 2010-2013
%-pt of GDP; dots show largest 4-yr chg prior to 2007 %-pt of GDP; dots show largest 4-yr chg prior to 2007
14 14
12 1997 12
1994
10 10 1985 1997
1994 1999
1997 1985 1999
1999 1999
8 1998 8 1997 1993
1990 1998 1984
6 1984 2006 6
1989 1993 1986
1979 1988 1997 2006 1998
4 1997 1995 4 1997 1997 1994
1999 2001 1997
2000 1985
1996
2 2
0 0
GRC
EUR
CAN
NLD
PRT
GBR
AUT
JPN
DEU
ESP
USA
FRA
CHE
AUS
SWE
ITA
IRL
BEL
NZL
GRC
CAN
EUR
DEU
NLD
PRT
GBR
AUT
JPN
ESP
USA
FRA
SWE
AUS
CHE
ITA
IRL
BEL
NZL
13
Fiscal consolidation: now versus then

2010-2013 Largest 4-year change prior to 2007
Chg in primary GDP grwth (ar) Ratio Years Chg in primary GDP grwth (ar) Ratio
US 7.6 3.0 0.6 1976-1979 4.4 4.7 0.2
Japan 1.4 2.2 0.2 2003-2006 5.6 2.0 0.7
Euro Area 3.4 1.5 0.6 1997-2000 2.8 3.1 0.2
Germany 2.1 1.8 0.3 1996-1999 8.0 1.7 1.1
France 4.7 1.6 0.7 1994-1997 3.5 1.9 0.4
Italy 0.6 1.4 0.1 1990-1993 4.8 0.8 1.5
Spain 8.7 0.9 2.5 1986-1989 5.1 4.7 0.3
Netherlands 1.0 1.8 0.1 1996-1999 8.8 4.1 0.5
Belgium 1.4 1.8 0.2 1982-1985 8.4 1.3 1.6
Austria 1.6 1.9 0.2 1996-1999 3.0 2.8 0.3
Greece 9.2 -0.6 n.a. 1991-1994 9.0 1.0 2.2
Ireland 5.7 1.2 1.1 1987-1990 6.7 6.0 0.3
Portugal 10.7 0.9 2.8 1981-1984 5.2 0.4 3.1
UK 9.7 2.4 1.0 1995-1998 7.1 3.2 0.5
Norway 4.6 2.2 0.5 1994-1997 10.2 4.9 0.5
Sweden 2.6 2.3 0.3 1994-1997 11.4 3.1 0.9
Switzerland 1.0 2.5 0.1 1998-2001 2.7 2.2 0.3
New Zealand 1.4 2.5 0.1 1992-1995 4.7 4.0 0.3
Australia 1.4 3.3 0.1 1985-1988 4.5 4.0 0.3
Canada 3.8 3.1 0.3 1994-1997 8.3 3.4 0.6
Average 4.2 1.9 0.6 6.4 3.0 0.8
Note: The table shows the change in the primary surplus (%-pts of GDP) over two periods: the forecast from 2010 to 2013, and the largest 4-year change from 1970 to 2007.
Annualized growth in GDP over the respective periods is also reported. The last column for each time period reports the change in the primary surplus as a ratio to GDP growth
over the same period (non-annualized). In this respect, the ratio shows the %-points of GDP change in the primary surplus per 1%-point of GDP growth. The GRC ratio for the
forecast period is not reported as GDP is expected to contrast over this period.
The synchronized consolidation of The projected fiscal consolidation is unique not because so few countries have seen
the DM is unique, even though some such a marked improvement in so little time, but because of the simultaneous effort
countries have experienced greater that will be made across the developed economies. While some countries are pro-
adjustments individually jected to see the largest four-year improvement in their fiscal condition in over 40
years, many have accomplished as much or more before. The largest consolidations
are projected for Portugal, the UK, Spain, Greece, and the US, with each expected
to see an 8%- to 11%-point of GDP rise in their primary balance. In each case, the
prospective fiscal adjustment will match or exceed any previous four-year gain
made between 1970 and 2007. The projected consolidation for these countries is
even more unprecedented when focusing on the structural primary balance.
The coming fiscal consolidation will face two significant headwinds not present in
previous experience. First, government borrowing rates will most likely be moving
higher in coming years, reversing a 15-year downtrend. The interest rate paid on gov-
ernment debt averaged 8.4% in 1982 across the developed markets. By 2009, this rate
had plunged to 3.3%. However, this decline is projected to reverse course and in-
Rising interest costs will increase the crease over the coming decade. Although this does not impact the primary deficit di-
difficulty of consolidation as will a rectly, it will add further pressure for greater fiscal consolidation to control the rise in
recovery that is modest relative to the
depth of the recession
debt stemming from higher interest costs.
Second, the outlook for economic growth appears more subdued than in past cir-
cumstances. History shows that recessions led by banking crises tend to be deeper
and are followed by shallower recoveries. Or, put differently, there appear to be
lingering structural headwinds that are expected to limit the pace of expansion to
about 2.5% per annum through 2013, considerably weaker than what normally
would be expected after such a severe recession. Consequently, although our fore-
cast looks for above-trend growth across much of the world, it will take longer than
14
normal before output gaps are closed and unemployment rates reach normal levels.
The shallower recovery will temper the improvement in the cyclical balance. It also
may put even more pressure on governments to enact structural tightening to limit
the additional rise in the debt and possible feedback on investor confidence and
government borrowing rates.
The historical record on fiscal consolidation during periods of weak growth is mixed.
The largest four-year changes in primary balances are projected for Portugal, Greece,
and Spain. For Portugal, the 10.7%-point of GDP tightening from 2009 to 2013 is
expected to take place on the back of just 1.0% average annual GDP growth. This is
2.7%-points of fiscal tightening per 1%-point of GDP growth. Notably, Portugal
holds the record in this respect, having increased its primary position by 5.2%-points
of GDP in 1981-84 at a time when real GDP grew by just 0.4% per year.
A framework for assessing debt sustainability

The surge in public sector debt since 2007 has raised concerns regarding the
sustainability of this burden. Indeed, perceived risk of sovereign default has risen
throughout most of the developed world since 4Q09. While there is no single metric
Debt sustainability is defined as that defines a sustainable fiscal position, one necessary condition for fiscal
maintaining the projected 2013 level sustainability is the ability to maintain a budget position that stabilizes the level of
of net debt relative to GDP debt relative to GDP.
With developed world budget balances currently in deep deficit, maintaining the
current level of debt is unlikely for all but a few countries. Consequently, debt is
projected to continue to rise this year and next. However, with the widespread and
significant fiscal consolidation expected over the next few years, it is worth
considering whether the ratio of debt to GDP can be stabilized by 2013.
In general, there are two factors that determine the fiscal position needed to achieve
Debt sustainability is determined by
debt sustainability—the initial level of net liabilities and the gap between the interest
the level of debt and the difference
between rates of interest and nominal rate paid on debt and the growth rate of nominal GDP. Because the primary budget
GDP growth balance excludes interest payments, a higher debt servicing burden requires a higher
offsetting primary balance to keep net liabilities unchanged. Thus, a higher level of
debt or a higher interest rate paid on that debt each imply a higher primary balance
needed for sustainability. At the same time, because debt sustainability refers to the
Fiscal deficit and credit risk Fiscal debt and credit risk
Bp; change in 5-yr sov CDS spread since Oct09 Bp; change in 5-yr sov CDS spread since Oct09
200 200
*657bp CDS change GRC* ESP GRC*
180 ESP 180
160 ITA 160 ITA *657bp CDS change
140 IRL 140
IRL
120 120
100 BEL 100 BEL
80 FRA 80
JPN USA FRA
60 60
USA JPN
40 AUT AUT
CHE
NZL
NLD GBR
40 AUS NZL GBR
CHE
20 AUS 20 DEU
DEU NLD
0 0
0 2 4 6 8 10 12 0 25 50 75 100 125 150 175 200
Fiscal deficit, 2010 (% of GDP) Gross financial liabilities, 2010 (% of GDP)
15
The dynamic fiscal budget constraint and sustainability

To gauge the ability to maintain a given debt to GDP ratio, it is most useful to analyze
the primary deficit as a percent of GDP. Because the primary deficit refers to the net
lending position of the general government excluding net interest payments, it is
inherently a “net-of-assets” concept, and so the appropriate measure for gauging
sustainability is net debt. Net debt (N) is defined as the difference between liabilities
and assets. Over time, Net interest paid on liabilities at rate r adds to net debt (this
analysis abstracts from both differential returns on assets and liabilities as well as
differential returns on debt maturing at different periods). The primary lending
position (P), which excludes net interest payments, also subtracts from net debt.
That is,
N t = (1 + r )N t −1 − Pt , (1)
where t subscripts reflect the year. Because it is more meaningful to scale fiscal
dynamics by the size of a country’s economy, the dynamic budget contraint can be
rewritten as ratios to nominal GDP, which grows at rate (g), where (n) and (p) are
ratios to GDP:
nt ≈ (1 + r − g )nt −1 − p t . (2)
This dynamic accounting identity provides the foundation for sustainability analysis.
The first metric of debt sustainability assumes the level of net liabilities (net debt) is
held constant at its current level. In this case, the above formula reduces to:
p * = (r − g )nt . (3)
The second metric examined in the main text argues that debt sustainability requires
a return to the level of net liabilities (as a % of GDP) that existed prior to the global
financial crisis. This metric can be derived by iterating the accounting identity (2)
forward and thus showing that the level of net debt at year k is a function of net debt
at year t and the path of primary balances between year t and year k. Assuming a
constant primary balance (and assuming a constant rate of interest and growth), this
can then be solved for the assumed constant level of the primary balance:
⎛ r−g ⎞
p * = ⎜⎜
− ( − )
( )
⎟ nt+k − (r − g )k nt .
k ⎟ (4)
⎝ 1 r g ⎠
These two metrics for debt sustainability, (3) and (4), are the focus of analysis in the
main text. Each is sensitive to the gap between the interest rate and the rate of
nominal growth and the level of net debt relative to GDP. These sensitivities are
discussed in detail in the main text.
debt ratio to GDP, stronger economic growth will reduce the required primary
balance. When the rate of interest is equal to the rate of nominal GDP growth, the
primary balance for debt sustainability is simply zero. That is, when the primary
balance is equal to zero, the impact of interest payments on the net debt to GDP ratio
are exactly offset by GDP growth. (See the text box for the derivation of the debt
Beyond 2013, the analysis uses sustainability metrics.)
estimates of potential nominal GDP
growth along with market forward For the debt sustainability analysis reported here, we use two different sets of
rates projections (see appendix table for details). Up through 2013, nominal GDP growth
is based on J.P. Morgan’s short-term business cycle projections. Beyond 2013,
nominal GDP growth is assumed to match potential GDP growth plus the rate of
inflation targeted by monetary policymakers. Inflation in the Euro area as a whole is
assumed to converge to the ECB target of 2% but is allowed to vary somewhat
according to historical deviations across the region. This allows some of the more
fiscally challenged economies to have higher levels of nominal growth.
16
Choosing the interest rate is less straightforward. Over long periods of time, the
interest rate and the rate of growth tend to track each other closely. However, interest
rates stray from nominal growth rates considerably over shorter periods of time,
even for 10- to 20-year periods. These deviations reflect numerous factors, including
inflation compensation as well as inflation and credit risk premia. Over the coming
years, the average interest rate on sovereign debt will reflect two opposing forces.
The first is the move down in rates during the global financial crisis. Government
borrowing rates will continue to be anchored by: highly accommodative monetary
policy, the lack of a full recovery in investor risk appetite, and the natural portfolio
shift of an aging population. Working in the opposite direction, rising concerns about
the sustainability of fiscal debt and associated worries about an eventual rise in
inflation will act to increase borrowing rates.
Forward rates on sovereign debt yields provide a guide to the net impact of the
forces that will be buffeting borrowing rates over the coming years. The interest rate
The projected rise in rates and fall in used for the debt sustainability analysis reported above is the 10-year forward rate on
potential growth adds almost 1%- sovereign debt of a tenor equal to the average maturity of existing debt, which varies
point to the DM fiscal position
required for debt sustainability
by country. To minimize the recent gyrations in debt markets, the average forward
rate over 1Q10 is used.
For the developed markets as a whole, the average interest rate is assumed to rise
from 4% prior to the global financial crisis to 4.7% over the coming decade. At the
same time, nominal potential growth is expected to fall from roughly 4% prior to the
crisis to about 3.5% over the coming years. This swing in the gap between the rates
on interest and growth from about zero to positive 1.2%-points adds 0.8%-point to
the required primary surplus for developed market debt sustainability when
multiplied by the projected net debt level of roughly 70% of GDP by 2013.
Low nominal growth and high debt
give Japan, Greece, and Italy the
Fiscal fundamentals are perhaps the most troubling in Japan, where an assumed low
worst basic fiscal fundamentals,
while strong growth aids the US interest rate of 3% is still much higher than the assumed long-run nominal growth
fiscal backdrop rate of just 1% that reflects a 1.0% potential real growth rate and a 0.0% medium-
term inflation outlook. When coupled with Japan’s extremely high level of net debt,
fiscal sustainability becomes a very high hurdle. The US, by contrast, faces much
higher interest rates but part of this reflects the higher inflation target, and potential
Fundamentals of fiscal sustainability, long-run assumptions Fundamentals of fiscal sustainability, long-run assumptions
%oya, nominal potential growth %-pt; gap between 10-yr fwd rate and potential growth
45 degree
5.5 IRL 3.0 GRC
Easier AUS DEU
5.0
fundamentals ESP NZL 2.5 ITA
4.5 USA
GRC Harder JPN
4.0 CHE AUT
GBR 2.0 PRT
SWE ITA fundamentals
3.5 NLD CAN
PRT 1.5 CAN
FRA NLD GBR FRA BEL
3.0 BEL
2.5 DEU ESP
1.0
AUT IRL
2.0 Easier
Harder 0.5 USA
JPN fundamentals
1.5 fundamentals
1.0 0.0
2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 25 50 75 100 125
Yield on sovereign bond debt at avg tenor, 10-yr fwd (1Q10 avg) Projected 2013 net debt (% of GDP)
Note: Norway, Sweden, Switzerland, Australia, and New Zealand are excluded
from the chart. Each has much easier fundamentals than those shown above.
17
growth is much stronger than in Japan. Still, the US’s relatively high debt ratio keeps
it within the middle of the pack in terms of its sustainability fundamentals.
Fiscal fundamentals are varied across Europe. Among the most fiscally challenged,
long-run interest rates are on the rise while potential growth is likely moving down.
Greece faces some of the worst fundamentals, with extremely high net debt by 2013
of 126% of GDP, high projected borrowing rates of 6.7%, and a projected slowing in
nominal potential growth to 3.9%. Italy is also expected to face relatively high
borrowing costs in the coming years. Combined with low nominal potential growth
rates, fiscal sustainability becomes more difficult to attain. By contrast, Portugal’s
lower interest rates and lower debt aid in efforts toward sustainability.
Lower debt and higher growth imply In Spain and Ireland, lower government debt and stronger growth yield less
easier fundamentals in Spain,
Portugal, and Ireland
concerning fundamentals despite higher borrowing rates. In the UK, solid potential
growth helps to offset some of the impact of projected higher interest rates, but this
makes for middling fundamentals once coupled with the high level of debt. Despite
Germany’s more modest level of debt and very low projected interest rates, weak
long-run nominal growth will be a drag on fiscal fundamentals. Not surprisingly, the
Scandis, along with Australia and New Zealand, each have the most favorable
fundamentals for debt sustainability.
Debt sustainability by 2013 not likely

Although there are large uncertainties surrounding these forecasts of growth and
interest rates over the coming decade, the exercise does provide a number of
Debt sustainability by 2013 requires important observations regarding the ability of developed world economies to
close to a 1% primary surplus, or a
1.9% total deficit, an unlikely prospect
achieve a stable debt postion.
despite the large planned consolida-
tions • For the entire developed market, a 0.9% of GDP primary surplus by 2013 is esti-
mated as necessary to hold net debt constant relative to GDP. Given projected
interest payments of 2.8% of GDP, this suggests a total net lending position of
-1.9% of GDP. In the past 40 years, this has been accomplished only briefly—in
the early 1970s and late 1990s, each at the peak of the economic cycle.
Fiscal sustainability of the general government
% of GDP
Net debt, 2013 Primary surplus, 2013 Change primary surplus, 2009 to 2013 Net lending, 2013
J.P. Morgan fcst J.P. Morgan fcst Maintain '13 debt J.P. Morgan fcst Maintain '13 debt J.P. Morgan fcst Maintain '13 debt
Developed markets 69.3 -1.2 0.9 5.2 7.3 -4.0 -1.9
US 74.2 -1.6 0.3 7.6 9.5 -4.5 -2.6
Japan 128.6 -5.1 2.5 1.4 9.0 -8.4 -0.8
Euro area 63.1 -0.1 1.1 3.4 4.6 -3.4 -2.2
Germany 56.3 1.4 1.4 2.1 2.1 -1.2 -1.2
France 67.4 -0.4 0.9 4.7 6.0 -3.5 -2.2
Italy 99.3 -0.1 2.3 0.6 3.0 -5.0 -2.6
Spain 55.5 -0.8 0.6 8.7 10.0 -3.7 -2.4
Netherlands 42.4 -2.1 0.5 1.0 3.6 -4.8 -2.2
Belgium 81.9 -0.8 1.0 1.4 3.2 -4.1 -2.3
Austria 40.9 0.9 0.4 1.6 1.1 -2.1 -2.6
Greece 126.3 0.6 3.4 9.2 12.0 -6.3 -3.5
Ireland 63.5 -4.0 0.6 5.7 10.3 -7.7 -3.1
Portugal 63.7 4.1 1.1 10.7 7.7 0.3 -2.7
UK 58.4 0.5 0.7 9.7 9.9 -2.2 -2.0
Norway -151.5 11.5 1.3 4.6 -5.6 14.2 3.9
Sweden -14.3 1.4 -0.0 2.6 1.1 1.6 0.1
Switzerland 9.9 0.7 -0.1 1.0 0.2 0.4 -0.4
Australia 2.2 0.5 0.0 1.4 1.0 0.3 -0.1
New Zealand -0.1 -1.8 -0.0 1.4 3.2 -1.7 0.1
Canada 27.3 0.9 0.4 3.8 3.2 -0.3 -0.9
Note. The "Maintain '13 debt" column shows the primary surplus (or change in primary surplus from 2009) required by 2013 to hold debt constant relative to GDP. The last two columns report net lending
positions, computed by subtracting projected net interest payments from the respective primary lending position. General government includes state and local municipalities. Bold values indicate
countries that will fail to reach debt sustainability by 2013.
18
• Achieving debt sustainability by 2013 is unlikely. As a region, the developed

markets require a 7.3%-point rise in the primary lending balance from its 2009
level to hold the debt to GDP ratio constant by 2013. Our forecast, based on solid
growth and full implementation of existing fiscal plans, anticipates a 5.2%-point
consolidation. Thus, it appears that debt sustainability will not be achieved until
the middle of this decade at the earliest.
Sustainability requirements are more

• In the US, the primary surplus required to maintain its projected 2013 debt to
modest in the US and UK given both GDP ratio is among the smallest at 0.3% of GDP despite a higher ratio of net debt
countries stronger growth potential, to GDP. Only the commodity-producing economies, where fiscal issues are of
but are much higher for Japan much less concern, require a smaller surplus (or even deficit). The US’s more
benign required primary surplus reflects the fact that, although interest rates are
likely to move up considerably from their current historic lows, nominal potential
growth is quite strong. The UK also faces a more modest required primary sur-
plus of 0.7% of GDP for debt sustainability owing to its stronger nominal growth
potential and contained borrowing rates, as implied by futures markets.
• Japan’s debt arithmetic is among the worst in the developed world. Although inter-
est rates have been remarkably low in Japan for well over a decade, so too has
nominal GDP growth. And with the economy again struggling with deflation, the
fundamentals of debt sustainability, when coupled with its record-high level of debt,
are daunting. On net, Japan needs to reach a 2.5% of GDP primary surplus by 2013
to maintain its projected level of debt, an 9%-point increase from the 2009 level.
• Absent further fiscal consolidation than is already planned, the US will fail to
achieve debt sustainability by 2013, falling short by 2%-points of GDP. Japan
Still, the US and UK will likely fall stands out as the largest underachiever by the metric examined here, with the pro-
short of reaching debt sustainability jected primary lending position in 2013 falling short of the target for
by 2013; Japan will fall the furthest
short among the DM
sustainability by 7.6% of GDP. Consequently, net liabilities in Japan look set to
rise at a rapid pace well past the middle of this decade even if much of Japan’s
sovereign debt is currently held domestically. By contrast, the UK is projected to
achieve debt sustainability under its latest consolidation plans.
• For the Euro area as a whole, debt sustainability is not a high hurdle at 1.1% of
GDP. The region is expected to fall short of achieving sustainability by 2013 by
just 1.2%-pt of GDP. Ignoring important political considerations, this suggests that
Primary surplus by 2013 to stabilize debt-GDP ratio Change in primary surplus by 2013 to maintain debt
% of GDP %-pt of GDP; change in primary surplus 2009 to 2013
3.3 12.0
3.0 10.5
2.7 Extra to maintain 2013 debt
9.0
2.4 J.P. Morgan projection
7.5
2.1
1.8 6.0
1.5 4.5
1.2 3.0
0.9
1.5
0.6
0.0
0.3
0.0 -1.5
-0.3 -3.0
JPN
ESP
USA
FRA
ITA
SWE
AUS
CHE
IRL
BEL
NZL
JPN
GRC
GBR
EUR
NLD
CAN
DEU
PRT
AUT
ITA
FRA
ESP
USA
AUS
SWE
CHE
BEL
IRL
NZL
GRC
DEU
NOR
EUR
PRT
GBR
NLD
CAN
AUT
19
Alternative measures of debt

Market anxieties surrounding debt sustainability are partly fueled by alternative
measures of debt. Of these, three are worth commenting on.
• Gross sovereign debt. The distinction between gross and net debt is often unnec-
essarily vague in the media and other reports on sovereign debt positions. Gross
debt refers to the financial liabilities of the government, while net debt subtracts
financial assets. Gross debt positions are consolidated in that they exclude intra-
governmental borrowing and lending (e.g., sovereign debt held in social security
trust funds). However, most governments hold considerable private sector finan-
cial assets. In general, gross and net debt move closely together, but because
there are significant differences in the levels, the distinction remains important.
Debt sustainability analysis should be done using net liabilities because the net
lending positions are themselves net concepts.
• Sovereign and household gross debt. Some argue that sovereign debt should be
examined in conjunction with private sector debt. One example of this argument
is that despite Spain’s Gross financial liabilities
relatively low govern-
% of GDP
ment debt to GDP ratio,
275
the combination with
household debt paints a Household (2008)
much different picture. 225 Government (2013 fcst)
Indeed, Spain’s gross
liabilities are almost 175
tripled when household
debt is added. However,
125
this is roughly true for
most countries: house-
hold debt is simply (and 75
not surprisingly) much
larger than government 25
JPN
GRC
NLD
NOR
DEU
PRT
GBR
CAN
AUT
USA
ITA
CHE
ESP
FRA
SWE
IRL
BEL
debt everywhere except

in Japan and—interest-
ingly enough—Greece. This is not to say there is no variation in household debt
across countries, but the relative debt rankings are not materially changed when
household debt is included.
(Continued on next page)
As a whole, the Euro area will come

a region-wide guarantee of sovereign debt, or the introduction of an EMU bond that
close to reaching debt sustainability assumes the debt of the region’s constituents, would effectively remove most if not
by 2013 all market concerns surrounding the fiscal crisis now engulfing the region.
• Within Europe, sustainability requirements vary considerably by country. At one
extreme, Germany requires a 1.4% primary surplus by 2013 for debt
sustainability, a relatively higher level compared to the US or UK, due to the
country’s low nominal potential growth rate. Still, this target is expected to be
met. France has a lower required surplus reflecting its higher potential growth
rate but is expected to fall short by 2013.
• Among the peripheral Euro area economies receiving the most attention of late,
fiscal sustainability is legitimately a more pressing matter according to the
20
• External gross debt (sovereign and private). Another measure of debt often
considered is external debt. External debt itself is measured in numerous ways.
Some define external debt as including only liabilities in foreign currency. In this
case, the US as well as External debt, 2009
most Euro area coun-
tries would have very % of GDP; private excluding monetary financial institutions
little external debt. It is 160
(Note: IRL: 574%, total)
a useful distinction in
140 Private ex. banks
that it can be important
in determining the like- 120 Government
lihood of default. 100
80
Another definition of
external debt concerns 60
the legal jurisdiction 40
under which the debt
was issued, an impor- 20
tant distinction for the 0
JPN
CHE
FRA
SWE
ESP
ITA
USA
AUS
IRL
BEL
GBR
NLD
EUR
PRT
GRC
AUT
NOR
DEU
CAN
potential restructuring
of debt. For example,
almost all Greek debt is issued under Greek law, presumably making any restruc-
turing more favorable for the Greek government. Notwithstanding the merits of
these definitions, the IMF, OECD, World Bank, UN, BIS, Paris Club, and
Eurostat (jointly) define external debt as “the outstanding amount of those actual
current, and not contingent, liabilities that require payment(s) of principal and/or
interest by the debtor at some point(s) in the future and that are owed to nonresi-
dents by residents of an economy.” There is thus no distinction made by currency
or legal jurisdiction.
Based on this definition for the external debt of the government and private sec-
tor (excluding banks), the cross-country rankings are somewhat altered compared
to those based on total sovereign debt. The UK and Netherlands each have very
elevated gross external debt positions even if Ireland, Portugal, and Greece re-
main near the top of the rankings. Still, gross external debt is hard to interpret as
it is distorted by large financial centers (like Ireland, UK, and the Netherlands).
metrics and assumptions used in this analysis. Greece and Italy face some of the
Greece faces the highest hurdle and
will not reach debt sustainability by more challenging fiscal hurdles. Based on market expectations for elevated bor-
2013 despite its large consolidation rowing rates well into this decade, along with very high net liabilities, the re-
plans quired primary surplus for sustainability for both countries is in league with Ja-
pan. At the same time, Greece was running one of the largest deficits in 2009 and
so faces one of the largest fiscal consolidations to reach debt sustainability by 2013,
a target it still expected to miss. By contrast, Italy is currently running one of the
smallest primary deficits and so requires a relatively modest amount of tightening
for sustainability. However, Italy is projected to miss this target, and so net debt
will continue reaching new highs past 2013.
• Because of its relatively strong potential growth rate and average debt level, Ire-
Ireland will fall far short of reaching land faces a rather low hurdle for debt sustainability. Still, given the massive
sustainability, while Spain and Italy
will be much closer
deficit currently in place, achieving this target will require the second largest fis-
cal consolidation in the developed markets. Although an aggressive plan has al-
ready been enacted, Ireland is expected to fall well short.
21
• Given its smaller level of net liabilities as a share of GDP along with its higher
level of potential growth, Spain does not require nearly as high a primary surplus
by 2013 as does Italy for debt sustainability. Still, given its large fiscal deficit as
of 2009, Spain’s required fiscal consolidation to achieve this target, at 10%-
points of GDP, is among the largest in the developed markets. Even if Spain is
able to implement the recently announced stability and growth plan, which is
among the most aggressive in the developed world, debt sustainability will re-
main out of reach by 2013.
Portugal is one of the few DM • Portugal’s relatively low level of net debt suggests a primary surplus for debt
economies expected to reach debt sustainability that is modest. Assuming the stability and growth plans are effec-
sustainability provided its massive
tively implemented in the coming years, Portugal’s expected considerable fiscal
consolidation plans are implemented
consolidation will be one of the few that actually exceeds what is necessary for
debt sustainability.
An alternative metric of debt sustainability
Given the recent collapse in fiscal positions, simply stabilizing debt levels relative to
GDP may not be enough to placate markets. A more acceptable—albeit more
challenging—path to sustainability could be to reduce debt to GDP ratios to the
levels seen prior to the global financial crisis. This adjustment is assumed to take
Returning debt ratios to 2007 levels place over a period of 10 years. To the extent that markets were less concerned about
within 10 years is next to impossible
fiscal sustainability in 2007, this is used as the benchmark year.
for most
Using this more demanding metric, the general contour of the required primary
surpluses is roughly the same although there are some notable changes in terms of
the ranking. For the developed markets as a whole, the primary surplus required to
return the projected debt ratio in 2013 to its 2007 level by 2023 is 3.4%-points, 2.5%-
points more than needed just to maintain the 2013 level of debt. In general, those
countries that saw a very large increase in debt during the crisis have a considerably
larger required primary surplus. The largest increase from the previous metric is for
Greece, requiring a sustained primary surplus of 7.8% of GDP to reduce the debt to
GDP ratio back to its 2007 level by 2023. Very large increases in the required
primary surpluses are also seen for Ireland, Portugal, and Spain, countries that ran up
huge amounts of debt over the past few years.
Primary surplus by 2013 for debt sustainability

% of GDP
8 Return to 2007 debt by 2023
7 Maintain 2013 debt
6
5
4
3
2
1
0
-1
JPN
ITA
FRA
ESP
USA
AUS
SWE
CHE
BEL
IRL
NZL
GRC
DEU
NOR
EUR
NLD
CAN
PRT
GBR
AUT
22
The massive rise in US net liabilities during the recession leads to a huge swing from
the relatively modest 0.3% primary surplus required to maintain the projected 2013
debt level to a much larger 3.1% surplus to achieve the 2007 debt ratio by 2023.
Japan and the UK also experienced huge increases in net liabilities during the crisis
and so returning to the 2007 ratio requires a much larger primary surplus than what
is needed to just stabilize debt at its elevated 2013 levels. By contrast, the moves up
in net debt in Germany and Italy during the crisis (and projected through 2013) were
smaller and thus so too is the required primary surplus to return that 2007 level.
Indeed, Italy’s ranking falls from requiring the third largest primary surplus to
maintain its debt level to sixth if the target is to return debt to its 2007 level, an
important reminder of the dependence of relative fiscal vulnerabilities on the metric
being used.
Sensitivity of debt sustainability

As is clear from the above discussion, the metrics used to gauge debt sustainability
are sensitive to the initial level of debt and the assumption about the gap between the
long-run interest rate and nominal growth. Measuring this sensitivity is
straightfoward. Based on the formulation of the metrics for debt sustainability, a 1%-
point rise in the interest rate or a 1%-point fall in nominal potential growth will lead
The sustainability exercise is sensi- to an increase in the required primary surplus for debt sustainability simply equal to
tive to interest rate and growth the current ratio of net debt to GDP times 0.01. For example, if net debt is 80% of
assumptions
GDP, then a 1%-point rise in the interest rate increases the required primary surplus
for debt sustainability by 0.8%-point of GDP.
The sensitivities of debt sustainability thus vary across countries by the level of net
debt. Japan and Greece face the most sensitivity, with the required primary surplus
rising almost 1.3%-point of GDP for every 1%-point rise in interest rates or 1%-
point shortfall in nominal GDP growth. This assumes net debt rises to roughly 125%
of GDP by 2013. Italy also faces more uncertainty around the required primary
surplus for sustainability, as does the US.
A more intuitive cross-country comparison of sensitivities is accomplished by

altering the assumptions used in the above sustainability analysis. Rather than
assume the 10-year forward market rates on sovereign debt, an alternative is to
assume that interest rates are equal to the nominal long-run growth rate, as theory
Sensitivity of required primary surplus for debt sustainability Change in primary surplus by 2013 to maintain debt
%-pt of GDP; impact from 1%-pt rise in interest rate or fall in growth % of GDP; change in primary surplus 2009 to 2013
1.4 12
1.2 10
Mkt fwd
1.0 interest rates
8 Interest rates =
GDP growth rate
0.8
6
0.6
4
0.4
2
0.2
0.0 0
JPN
ESP
USA
FRA
ITA
SWE
AUS
CHE
IRL
BEL
NZL
GRC
GBR
EUR
NLD
CAN
DEU
PRT
AUT
JPN
GRC
EUR
NLD
CAN
PRT
GBR
DEU
AUT
ITA
USA
FRA
ESP
CHE
BEL
IRL
23
Speed bumps on the road to debt-induced inflation

One aspect of the anxieties surrounding the sharp deterioration in public finances
over the past two years is the potential for inflation to become the policy tool of
choice for controlling debt. As coined by Nobel laureate Milton Friedman, “Infla-
tion is always and everywhere a monetary phenomenon.” By implication, the link
between fiscal positions and inflation requires a central bank to monetize govern-
ment debt. So long as a central bank maintains independence and its commitment to
price stability—by way of a credible inflation target—there is little risk of fiscal
debt leading to elevated and rising inflation. Simply put, if money growth is fixed,
the fiscal budget constraint must be obeyed in that current deficits must be matched
by future surpluses, absent default.
Alternatively, if monetary independence is weak or being challenged, there is a risk

that the central bank, which is ultimately a subordinate government entity, is forced
to step in and fund persistent fiscal irresponsibility. It is thus little surprise that
weak central banks combined with fiscally irresponsible governments have histori-
cally been a recipe for high inflation. Ironically, the longer the central bank main-
tains its commitment to price stability in the face of continued fiscal shortfalls, the
larger the increase in debt and the greater the level of monetization (and inflation)
needed to satisfy government’s financing needs.1 Moreover, the larger the share of
foreign creditors, the higher the incentive to monetize the debt.
Despite this accounting arithmetic that forces either fiscal responsibility or mon-
etary irresponsibility, there are a number of reasons that make the latter choice less
effective in reducing debt levels:
• Expected inflation is no panacea. Monetary funding of fiscal irresponsibility

would lead to a move up in inflation expectations that would, in turn, be included in
the cost of borrowing. The expected monetization of fiscal debt is thus counterpro-
ductive as it raises the debt service burden on new issuance while the loss of a
nominal anchor (inflation expectations) eventually damps economic activity. This
costly lesson of the 1970s remains a fact (not a choice) of modern policymaking,
and will not be easily forgotten. Indeed, despite runaway inflation in that decade,
fiscal debt remained largely unchanged as debt servicing rose considerably. In re-
sponse to these lessons, the importance of central bank independence has become
much more appreciated, even by the majority of elected officials.
• Many fiscal obligations are indexed. The rise of inflation linked debt securities
has diminished the incentive to use inflation as a debt reduction tool. However,
the share of overall debt that is linked to inflation remains relatively small
(around 5% in the US). More importantly, however, is the fact that much of the
unfunded pension obligations are also linked to inflation. Consequently, any re-
duction in the real value of existing non-indexed debt would be partly offset by
the implicit increase in future obligations.
• An aging constituency. Related to the large unfunded obligations linked to infla-
tion is the increase in the share of the voting public that is moving into a part of
their life cycle where inflation is particularly damaging. With much of private
sector wealth held in nominal terms, it is unlikely that the monetary authority
could politically weather a sharp rise in inflation.
1. These dynamics were developed in the seminal paper by T. Sargent and N. Wallace, “Some unpleasant monetarist arithmetic,”
Federal Reserve Bank of Minneapolis Quarterly Review 5(3), 1981.
24
dictates should be true over time in the absence of risk premia. In this context, the
Sustainability hurdles are the most difference between the market forward rates and the zero-risk rate is a gauge of the
sensitive to the assumptions for high
degree to which market concerns are adding to the challenges being faced by
debt countries
governments to consolidate.
Because forward rates for long-term government debt are somewhat above the assumed
nominal potential growth rates for most countries, assuming away this gap yields
easier primary surpluses required for debt sustainability by 2013. In turn, the required
magnitude of fiscal consolidation is reduced. Clearly, those economies that faced the
largest gap between the interest rate and nominal growth benefit the most from this
exercise. This includes Japan, Italy, Greece and Portugal. Given the US’s relatively
high nominal growth rate, assuming a zero rate growth gap is much less beneficial.
Beyond the arithmetic of fiscal sustainability

With almost all developed market governments starting from record deficits, the path to
fiscal sustainability is guaranteed to be long and painful. As detailed above, the interest
Calculus of debt sustainability rate and growth rate of economic activity are important for defining this path. While the
involves more than accounting sensitivities to these assumptions are easily quantified, the larger unknown is in the will-
arithmetic
ingness and ability of a government to reach debt sustainability given the substantial
magnitude of the challenge faced. Indeed, underneath the arithmetic of debt dynamics
are a number of forces that will be instrumental in determining whether fiscal
sustainability is ultimately achieved in the coming years. These forces can be significant
impediments but in some cases can also provide unique opportunities.
The size of government

In developed markets, the governments’ presence in economic activity has in-
creased steadily over the past few decades, a rise that was amplified considerably
during the global financial crisis. For the region as a whole, general government
receipts amount to 38.6% of all gross domestic income. In general, the relative size
of government is appreciably larger in Europe than in the US and Japan. Govern-
ments in Western Europe take in between 45% and 55% of gross domestic income,
in contrast to the 35% taken in the US and Japan. This pattern also holds for outlays
across the developed markets.
General government receipts and outlays, 2007

% of GDP (bars are receipts, dots are outlays)
60
55
50
45
40
35
30
JPN
SWE
FRA
DNK
ITA
ESP
AUS
USA
CHE
BEL
IRL
NZL
ISL
DM
NOR
FIN
NLD
EUR
DEU
PRT
GBR
CAN
GRC
AUT
25
Given the range of spending and revenue shares, the inherent impediments to alter-
ing tax and spending patterns could differentially affect the feasibility of debt
sustainability. The large required fiscal consolidations can be achieved by either
reducing outlays or increasing receipts. Conventional wisdom suggests it is easier
to raise revenue than to reduce spending. With a large share of the voting populace
moving into an age group that depends heavily on government transfers and out-
lays, cutting spending will become increasingly difficult.
European economies lack the option In this case, Western Europe faces a higher hurdle for debt sustainability in that the
of scaling up the fiscal footprint that size of the government is already relatively large. By contrast, the US and Japan
is available to the US and Japan
have more room to increase the size of government. Indeed, there is little doubt that
taxes in the US are on the rise, particularly for higher-income individuals. Simply
put, the US has the option of becoming—or at least moving toward—“Europe,”
while Europe is already “Europe.” Even if the US government scaled up to the bot-
tom of the European range, this would increase the primary surplus by as much as
10%-pts of GDP.
Some of the most fiscally challenged economies in Europe have smaller fiscal foot-
prints relative to the rest of the region. Government revenues in Spain and Greece
make up about 40% of GDP, considerably lower than the Euro area-wide average
of about 45%. Consequently, as with the US and Japan, an increase in taxation that
placed fiscal conditions on sounder footing would just bring the overall size of the
government in alignment with the rest of the Euro area.
Increasing the size of the government does not come without its own potential haz-
Rising government involvement in ards. While recognizing the complexities of the issue, there is a tendency for a
economic activity could do more
harm than good in the long run
larger fiscal footprint to be associated with diminished potential for economic
growth. On average over the past two decades, a 10%-pt higher government rev-
enue share of GDP has been associated with a 0.7%-pt lower rate of potential
growth and a 1.2%-pt higher level of structural unemployment. The relationship is
far from perfect, and the direction of causation is unclear. Still, the results raise the
risk that attempts to raise the scale of government to achieve debt sustainability
could be counterproductive as increased inefficiencies outweigh revenue gains.
Size of government and economic growth, 1990-2007 avg. Size of government and structural unemployment, 2006
Potential growth, % saar (1990-07 avg) NAIRU, %

3.4 9.5 ESP
ESP
AUS GRC DEU FRA
8.5
3.0 USA GRC NOR BEL
NZL EUR FIN
CAN
NLD 7.5 SWE
2.6 GBR FIN PRT
ITA
AUT SWE 6.5
PRT CAN
2.2 BEL
EUR 5.5 GBR AUT
AUS
USA
FRA IRL y = 0.12x+1.1, R2 = 0.20
1.8 4.5 JPN
CHE DEU NZL (Ex. NOR)
JPN y = -0.07x+5.8, R2 = 0.21 CHE
ITA (Ex. JPN, CHE, NOR) NLD NOR
1.4 3.5
30 35 40 45 50 55 60 30 35 40 45 50 55 60
General government receipts, % of GDP (1990-07 avg.) General government receipts, % of GDP
26
US state and local budget problems in perspective

In thinking about the complex fiscal crisis afflicting the members of the Euro area,
comparisons sometimes are made with the member states of the US. There are simi-
larities, of course: as with countries in the Euro area, US states share a common
currency and monetary policy. The structural differences appear more important,
however.
• US state governments are required to balance their operating budgets each year.
Although there is wiggle room in these requirements, they nonetheless impose a
good measure of fiscal discipline. The states faced a combined ex-ante budget
shortfall of about $200bn in 2010, or 1.4% of US GDP. These gaps were closed
through a combination of spending cuts, withdrawals from reserves, revenue in-
creases, and use of federal stimulus dollars. The combined projected budget
shortfall that needs to be met in FY 2011 is currently about 0.8% of GDP.
• US state debt burdens are low. The limited capacity to run deficits means the
states have not accumulated a lot of debt. Indeed, the combined debt of all US
state and local governments amounts to about 17% of US GDP. This pales in
comparison to the debt levels of DM central governments, including the Euro
area countries.
• US states are part of a powerful fiscal union. In a normal year, the US federal
government raises revenue equal to about 20% of GDP and about 20% of this is
transferred directly to state and local governments. This contrasts markedly from
the EU, which only raises about 1% of GDP in revenue. Moreover, in the US,
these transfers increase during economic downturns according to the degree of
stress in different parts of the country. This aids in smoothing relative economic
performance. In addition to these “automatic stabilizers,” the federal government
also can direct one-time stimulus to the states. In the 2008-09 recession, this
stimulus took the form of direct aid to state and local governments (amounting to
about $140 billion), as well as indirect aid, which includes reductions in federal
income tax rates as well as infrastructure spending.
US state deficit and debt, selected states Intrastate fiscal transfers, select states
% of GDP Fed. spending received less fed. taxes paid
Projected deficit Debt $bn %GDP
FY10 FY11 FY07 Virginia 34.9 9.9
Massachusetts 1.5 0.7 24.6 Louisiana 19.1 10.4
New York 1.8 0.7 22.7 Alabama 17.4 11.5
Pennsylvania 0.9 0.7 20.2 Mississippi 13.7 17.3
Michigan 0.7 0.5 19.1 Kentucky 12.7 9.1
Colorado 0.6 0.6 18.6 New Mexico 10.7 15.8
Illinois 2.3 2.1 18.4 West Virginia 7.3 13.7
New Jersey 1.9 2.3 18.0 Arkansas 6.5 7.5
Florida 0.8 0.6 18.0 Colorado -4.7 -2.2
California 2.8 0.5 17.9 Nevada -6.0 -5.4
Texas 0.3 0.4 15.5 Massachusetts -7.2 -2.3
Connecticut 2.2 2.4 15.1 Minnesota -9.5 -4.1
Ohio 0.8 0.6 14.5 Connecticut -9.5 -5.0
Virginia 0.9 0.3 12.8 Illinois -19.0 -3.4
Georgia 1.1 1.1 12.2 New York -23.8 -2.5
Total US states 1.4 0.8 17.0 New Jersey -27.5 -6.5
California -47.6 -2.9
27
Institutions and the preconditions for growth

Some inefficiencies go well beyond the relationship between the scale of govern-
ment and growth. These include the degree to which the fundamental preconditions
for growth are present or not. Absent these preconditions, fiscal sustainability be-
comes almost insurmountable. Indeed, it is not a coincidence that the same econo-
mies now undergoing the most financial market scrutiny are also those that face the
highest hurdles to fiscal sustainability against a backdrop of widespread macroeco-
nomic inefficiencies.
Based on several indicators of macroeconomic institutions, the most fiscally

stressed European economies all stand out as facing the weakest fundamentals. Ac-
Peripheral European economies face cording to the World Bank’s Ease of Doing Business index—a measure that quanti-
a weaker institutional macroeco- fies for 183 countries the regulatory difficulties businesses face in engaging in eco-
nomic backdrop... nomic activity—Greece ranks 109th, Italy 78th, Spain 62nd, and Portugal 48th. By
contrast, Germany ranks 25th, Japan 15th, the UK 5th, and the US 4th. According
to the World Economic Forum’s Global Competitiveness Index—a measure of the
strength of macroeconomic, political, legal, and social institutions based on both
hard data and survey data of leading business executives across 133 countries,
Greece ranks 71st, Italy 48th, Portugal 43rd, and Spain 33rd.
The relative weakness of these fundamental institutions have done more than re-
duce productivity and potential growth. It has also generated a burgeoning shadow
...as well as larger shadow econo- economy, whereby economic activity evades government taxation. According to
mies; both present challenges as well one estimate, the largest developed market shadow economies are found in Greece,
as opportunities Italy, Spain, and Portugal. In these economies, legal market-based economic activ-
ity that is deliberately concealed from the government amounts to between 20% and
30% of reported GDP. These estimates exclude all illegal and non-market based
activity. In Germany, the shadow economy is estimated at 17%, while in Japan and
the US, it is around 10%.
Impediments to fiscal sustainability, developed markets Size of the shadow economy, developed markets
Rank, global % of GDP
110 30
100 Ease of doing business index

25
90
80
20
70 Global competitiveness index
60
15
50
40 10
30
20 5
10
0 0
GRC
CAN
NLD
PRT
NOR
DEU
GBR
AUT
JPN
ITA
ESP
SWE
FRA
AUS
CHE
USA
BEL
IRL
NZL
GRC
NLD
DEU
CAN
PRT
AUT
JPN
NOR
GBR
ITA
ESP
FRA
CHE
SWE
USA
AUS
BEL
NZL
IRL
Note: The ease of doing business index is produced by the World Bank (2010) and provides a quantitative measure of regulations for starting a business, dealing with construction
permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and closing a business—as they
apply to domestic small and medium-size enterprises. The index ranks 183 countries and is based on World Bank assessments of rules and regulations as well as estimate of the
time to perform certain tasks. The global competitiveness index is produced by the World Economic Forum (2010) and measures competitiveness as the set of institutions, policies,
and factors that determine the level of productivity of a country. The index covers 133 countries and is based on hard source data as well as a survey of business executives.
Estimates of the shadow economy come from "Shadow Economies of 145 Countries All over the World (Schneider, 2006), where the shadow economy is defined as market-based
legal production of goods and services that are deliberately concealed from public authorities for the purporses of avoiding taxation or adhering to certain regulations.
28
Although the fundamentals are far from ideal for those economies that face the
longest path to fiscal sustainability, the starting position presents numerous oppor-
tunities not faced by those economies operating with much stronger institutions.
Changing institutions is by no means easy, but doing so can have a powerful effect
on economic growth and generate a boost to government revenues. Regulatory re-
forms would be a critical first step toward encouraging growth and also reabsorbing
the shadow economy. That said, even a greater enforcement of existing tax laws in
the existing economy would have a huge positive impact on fiscal balances. Based
on a 1996 estimate, as much as 20% of all tax liabilities in Greece went unpaid.1
Tax evasion amounted to 25% in Spain and 35% in Italy.
Demographics and entitlement spending

The debt sustainability analysis reported in the previous section abstracts from the
huge increase in public spending related to the aging of the developed market popu-
Aging populations are by far the lations. These costs are beyond those in the medium-term forecasts considered
greatest challenge facing every DM above. But, if nothing is done to alter the existing policy structure, they will ex-
government in the coming decades plode public debt in the coming decades. As with the every other challenge to fiscal
debt sustainability, the southern European economies face the largest hurdles.
The first cohort of the baby boom generation turns 65 in 2011, leading the way for
what will be a massive shift in the age distribution of every developed market
economy. As of 2008, there were roughly two working age individuals (age 15 to
65) for every dependent (age less than 15 or greater than 65), a “dependency ratio”
of 50%. By 2050, this ratio will surge to 73%, or 1.4 working individuals for every
dependent. There is widespread variation around this aggregate. For as much atten-
tion as the US baby boom generation receives, the US aging problems—with a de-
Peripheral European economies face
the most difficult demographics
pendency ratio that is expected to rise from 49% in 2008 to 67% by 2050—are not
as bad as those in other developed economies. The largest shift in the age distribu-
tion is projected for Japan and the southern European economies. By 2050, these
economies will face close to one dependent for every working-age individual. In-
deed, the populations in Spain and Italy are expected to age faster than in Japan
over the coming decades, reflecting a sharp fall in fertility rates.
Dependency ratio Change in government spending on pensions and health

%; population aged <15 or >65 relative to those aged 15-65 care, 2010 to 2050
90 %-point of GDP
Change by 2050 18
85
2008 16 Health care (incl. long-term care)
80
75 14 Pensions
70 12
65 10
60 8
55 6
50 4
45 2
40 0
DM
JPN
GRC
EUR
DEU
NOR
CAN
NLD
PRT
AUT
GBR
ESP
ITA
FRA
AUS
USA
SWE
CHE
IRL
NZL
BEL
JPN
ESP
AUS
FRA
ITA
USA
SWE
IRL
NZL
BEL
DM
GRC
NLD
EUR
CAN
DEU
PRT
GBR
1. Chang, W.N et al., “Measurement of value added tax evasion in selected EU countries,” CESifo Working Paper, No.431.
29
With dependency ratios on the rise, fiscal outlays relating to social security are pro-
jected to increase considerably as inadequately funded programs transition from net
inflows to large net outflows. Based on OECD estimates, developed market public
spending on pensions is expected to rise by 2%-pts of GDP between 2010 and
Public sector pension spending in the
DM will increase by 2%-points of GDP 2050. The largest increases will be seen in Greece, Portugal, Ireland, and Spain,
by 2050 with each seeing between a 7%- and 10%-pt of GDP rise. By contrast, the increase
in most of the major developed economies amounts to about 2%-pts. The smallest
projected increase is surprisingly in Italy, despite it having the second highest de-
pendency ratio by 2050. This relatively benign outcome reflects the significant pen-
sion reform Italy enacted in the 1990s. The shift from a defined benefit, unfunded
pay-as-you-go system to a funded notional defined contribution plan is a potential
model for other countries. The US’s social security reforms in the 1980s also made
its demographic problems manageable.
Although the rise in social security costs is daunting, this pales in comparison to the
projected cost increases associated with health care. In general, an aging population
impacts fiscal finances through numerous channels. First, because most health care
programs are inadequately funded, a shift in the age distribution increases outlays
while also reducing revenues. Second, health care costs rise with age, thereby rais-
ing the average per capita outlay. Third, increased demand on the health care sys-
tem will push up the price of health care. Combined, these factors point to a surge
in health care costs in the coming decades. For the developed markets, fiscal spend-
ing on health and long-term care as a share of GDP are expected to rise by 5.6%-pts
by 2050, according to the OECD.
Public sector health care spending in The looming rise in health care costs can be found across all dimensions of medical
the DM will increase by almost 6%- outlays. According to one study, total spending on ischemic strokes (the most com-
points of GDP by 2050 mon) will surge from $66 billion in 2008 to over $2 trillion by 2050.1 Absent any
effort to reduce risk factors (e.g., obesity) or reform stroke care, the public sector
will undoubtedly bear most of this cost. Also in the US, Medicare spending related
to Alzheimer’s disease—for which treatment costs are rising and mortality rates are
falling—is expected to double from $91 billion in 2005 to $190 billion by 2015 and
rise tenfold to over $1 trillion by 2050.2
Despite variation in the coming demographic shift, the OECD projected impact of
health care expenses on fiscal spending is remarkably constant. In general, those
economies that are aging the most are expected to have lower health care costs per
capita. By contrast, the US, for example, has one of the slowest-aging populations
but will face one of the larger increases in health care costs. Consequently, while
public sector health and long-term care is projected to rise 5.1%-pts of GDP in the
US, it is only expected to rise between 6.5%- and 7%-pts in Ireland, Greece, and
Italy. Put differently, the standard deviation in the projected rise in public health
and long-term care costs is less than 1%-pt in contrast to 3%-pts for the rise in pub-
lic sector pension costs.
The largest increase in entitlement
spending is expected in Greece,
Absent changes to existing policies, these aging dynamics make debt sustainability
Portugal, and Ireland, amounting to
13 to 17%-points of GDP seemingly impossible. Developed market fiscal outlays for pensions and health and
long-term care are expected to rise by almost 8%-pts of GDP, with every economy
facing a considerable increase. In Greece, Portugal, and Ireland, these costs are ex-
pected to surge between 13%- and 17%-pts of GDP. The rise in Italy is much
smaller given its significant pension reforms but still large at 7%-pts. The cost in-
1. D.L. Brown, et al., “Projected costs of ischemic stroke in the United States,” Neurology (67), 2006.
2. K. Schwartz, “Projected costs of chronic diseases,” Health Care Cost Monitor, 2010..
30
creases, when coupled with reduced revenues, present by far the largest challenges
to fiscal debt sustainability, but at the same time, present huge opportunities for re-
ducing costs. Pension reforms have already generated large-scale cost savings. Con-
taining health care costs will be less manageable given the moral and ethical dimen-
sions. This leaves efficiency gains as the most obvious form of cost control, which
could be considerable given the wide range of health outcomes in relation to per
capita health care spending.
APPENDIX TABLE: Assumptions underlying the sustainability analysis

Growth and inflation rates are %yoy, saar; Interest rates are %p.a.
GDP growth GDP inflation Interest rate
2010-13 Long-run 2010-13 Long-run 2010-13 Long-run
Developed markets 2.4 1.8 1.2 1.7 3.5 4.7
US 3.0 2.3 1.3 2.0 3.6 4.7
Japan 2.2 1.0 -0.8 0.0 1.7 3.0
Euro area 1.5 1.6 1.5 1.9 3.7 5.2
Germany 1.8 1.3 1.5 1.1 3.4 5.0
France 1.6 1.5 1.5 2.1 3.4 4.9
Italy 1.5 1.5 1.6 2.0 4.2 5.9
Spain 0.9 2.0 1.7 2.5 4.2 5.7
Netherlands 1.8 1.5 1.4 1.8 3.7 4.6
Belgium 1.8 1.6 1.5 2.0 3.4 4.8
Austria 1.9 2.0 1.3 1.7 4.2 4.8
Greece -0.6 1.4 2.3 2.5 4.6 6.7
Ireland 1.3 2.7 1.1 2.5 4.0 6.2
Portugal 1.0 1.4 1.2 2.0 4.5 5.2
UK 2.4 1.8 2.3 2.0 3.9 5.1
Norway 2.2 2.8 2.4 2.0 1.8 3.9
Sweden 2.3 1.6 1.6 2.0 1.2 3.8
Switzerland 2.5 1.8 1.3 2.0 2.8 2.6
Australia 3.3 2.9 2.1 2.0 6.3 5.7
New Zealand 2.5 2.4 1.9 2.0 4.5 6.0
Canada 3.1 1.6 2.3 2.0 4.4 5.0
Note. Forecasts for 2010 to 2013 are based on J.P. Morgan staff projections. Long-run GDP growth assumptions are based on OECD
estimates for potential growth from 2012 to 2025. Long-estimates for GDP inflation are based on central bank targets, although some
judgmental variation is allowed for within the Euro area. Long-run interest rates are based market forecasts for sovereign debt yields 10-
years forward at the current average tenor of existing debt. To avoid the interest rate gyrations from the previous few months, the average
rate over 1Q10 is used.
31
J.P. Morgan Global Issues

Government debt sustainability in the age of fiscal activism, Joseph Lupton, David Hensley, June 2010
Central bank exits and FX performance, Joseph Lupton, Gabriel De Kock, December 2009.
JGB challenge: Exploding public debt amid falling domestic saving, Masaaki Kanno, Masamichi Adachi,
Reiko Tokukatsu, Hitomi Kimura, October 2009.
Manufacturing bounce to launch global recovery, David Hensley, Joseph Lupton, July 2009.
Slack attack: low utilization rates, disinflation, global policy response, Joseph Lupton, David Hensley, May 2009.
Bouncing toward Malaise: a roadmap for the coming US expansion, Bruce Kasman, Michael Feroli,
Robert Mellman, Nikolaos Panigirtzoglou, May 2009.
EM inflation: Trouble beyond the headlines, David Hensley, Joseph Lupton, Luis Oganes, July, 2008.
Credit and growth: the case for the Euro area, David Mackie, Greg Fuzesi, Silvia Pepino, Nicola Mai and
Malcolm Barr, June 2008.
Sovereign Wealth Funds: A Bottom-up Primer, David Fernandez and Bernhard Eschweiler, May 2008.
Profit margins to fall, Nikolaos Panigirtzoglou and Joseph Lupton, April 2008.
How will the crisis change markets?, Jan Loeys and Margaret Cannella, April 2008.
The odd decouple, Joseph Lupton and David Hensley, December 2007.
So much depends upon a grand experiment, Bruce Kasman, Jan Loeys, David Hensley, Joseph Lupton
and Nikolaos Panigirtzoglou, July 2007.
Longevity: a market in the making, Jan Loeys, Nikolaos Panigirtzoglou and Ruy Ribeiro, July 2007.
Central bank communication hits diminishing marginal returns, David Mackie, George Cooper, Vasilios
Papakos, Nicola Mai and Malcolm Barr, May 2007.
The rise and fall of US potential: US potential GDP growth is slowing to 2.5%, Bruce Kasman, Robert
Mellman and Michael Feroli, September 2006.
Are alternative the next bubble?, Jan Loeys and Nikolaos Panigirtzoglou, September 2006.
Skimming froth from the punchbowl. Tracking the US housing turndown, Bruce Kasman, Michael Feroli,
David Hensley, Robert Mellman, May 2006.
Corporates in the sweet spot: high profits and saving to delay asset repricing, David Mackie, Bruce
Kasman, Nikoloas Panigirtzoglou and Jan Loeys, April, 2006.
Analysts’ Compensation: The research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback,
competitive factors and overall firm revenues. The firm’s overall revenues include revenues from its investment banking and fixed income business units. Principal Trading: JPMorgan and/or its affiliates
normally make a market and trade as principal in fixed income securities discussed in this report. Legal Entities: J.P. Morgan is the global brand name for J.P. Morgan Securities Inc. (JPMSI) and its non-
US affiliates worldwide. J.P. Morgan Cazenove is a brand name for equity research produced by J.P. Morgan Securities Ltd.; J.P. Morgan Equities Limited; JPMorgan Chase Bank, N.A., Dubai Branch; and
J.P. Morgan Bank International LLC. J.P.Morgan Securities Inc. is a member of NYSE and SIPC. JPMorgan Chase Bank, N.A. is a member of FDIC and is authorized and regulated in the UK by the Financial
Services Authority. J.P. Morgan Futures Inc., is a member of the NFA. J.P. Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services
Authority. J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated
by the Hong Kong Monetary Authority. JPMorgan Chase Bank, Singapore branch is regulated by the Monetary Authority of Singapore. J.P. Morgan Securities Asia Private Limited is regulated by the MAS
and the Financial Services Agency in Japan. J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) (JPMSAL) is a licensed securities dealer. J.P.Morgan Saudi Arabia Ltd. is authorized
by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA), licence number 35-07079. General: Information has been obtained from sources believed to be reliable but JPMorgan does not warrant
its completeness or accuracy except with respect to disclosures relative to JPMSI and/or its affiliates and the analyst’s involvement with the issuer. Opinions and estimates constitute our judgment at the date
of this material and are subject to change without notice. Past performance is not indicative of future results. The investments and strategies discussed may not be suitable for all investors; if you have any
doubts you should consult your investment advisor. The investments discussed may fluctuate in price or value. Changes in rates of exchange may have an adverse effect on the value of investments. This material
is not intended as an offer or solicitation for the purchase or sale of any financial instrument. JPMorgan and/or its affiliates and employees may act as placement agent, advisor or lender with respect to securities
or issuers referenced in this report.. Clients should contact analysts at and execute transactions through a JPMorgan entity in their home jurisdiction unless governing law permits otherwise. This report should
not be distributed to others or replicated in any form without prior consent of JPMorgan. U.K. and European Economic Area (EEA): Investment research issued by JPMSL has been prepared in accordance
with JPMSL’s Policies for Managing Conflicts of Interest in Connection with Investment Research. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and
49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (all such persons being referred to as “relevant persons”). This document must not be acted on or relied on by persons
who are not relevant. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with these persons. In other EEA countries, the
report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to “wholesale clients”
only. JPMSAL does not issue or distribute this material to “retail clients.” The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL.
For the purposes of this paragraph the terms “wholesale client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Canada: The information contained herein
is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein,
in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant
Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant
province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada
and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province
or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way
passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offense. Korea: This report may have been
edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul branch. Revised March 1, 2010. Copyright 2010 JPMorgan Chase Co. All rights reserved. Additional
information available upon request.
32

Government Debt Sustainability in The Age of Fiscal Activism

Încărcat de

Informații document

Descriere originală:

Titlu original

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Government Debt Sustainability in The Age of Fiscal Activism

Încărcat de

Drepturi de autor:

Formate disponibile

JPMorgan Chase Bank, New York

Government debt sustainability in the age

Contents: Page Government debt sustainability in the age of fiscal activism

Fiscal deficit and gross debt, developed markets

Metrics of fiscal debt sustainability

Progress in putting fiscal conditions on sounder footing will ultimately be judged

A number of headwinds will make implementing such a large region-wide fiscal

The anatomy of a fiscal blowout

Discretionary fiscal stimulus during the crisis

Source: OECD Economic Outlook, May 2010; J.P. Morgan

Decomposing the deterioration into cyclical and structural components highlights

General government outlays General government revenues

Change in net liabilities, developed markets

Debt of the general government

Fiscal balances have become more procyclical

4 1.5 4 Output gap 4

Fiscal policy's relationship to the business cycle

Largest fiscal consolidation in over 40 years

Change in the primary balance, developed markets

Change in primary surplus, 2008 to 2013

G-3 fiscal impetus from 2007 to 2013

-3 ------------ USA ------------ ------------ EUR ------------ ------------ JPN ------------

Fiscal consolidation: now versus then

A framework for assessing debt sustainability

The dynamic fiscal budget constraint and sustainability

Debt sustainability by 2013 not likely

• Achieving debt sustainability by 2013 is unlikely. As a region, the developed

Sustainability requirements are more

Alternative measures of debt

debt everywhere except

As a whole, the Euro area will come

Primary surplus by 2013 for debt sustainability

Sensitivity of debt sustainability

A more intuitive cross-country comparison of sensitivities is accomplished by

Speed bumps on the road to debt-induced inflation

Alternatively, if monetary independence is weak or being challenged, there is a risk

• Expected inflation is no panacea. Monetary funding of fiscal irresponsibility

Beyond the arithmetic of fiscal sustainability

The size of government

General government receipts and outlays, 2007

Potential growth, % saar (1990-07 avg) NAIRU, %

US state and local budget problems in perspective

Institutions and the preconditions for growth

Based on several indicators of macroeconomic institutions, the most fiscally

100 Ease of doing business index

Demographics and entitlement spending

Dependency ratio Change in government spending on pensions and health

APPENDIX TABLE: Assumptions underlying the sustainability analysis

J.P. Morgan Global Issues

S-ar putea să vă placă și