Public Debt Management
“A national debt, if it is not excessive, will be to us a national blessing”
– Alexander Hamilton
Public debt is the blueprint for how governments manage budgetary deficit between revenues and expenditures which are typically bridged by Government borrowing, monetary control and taxation. It is an imperative element of the fiscal policy in which governments try to strike a reasonable balance between what they are spending and what they earn.
With the memories of the most recent financial crisis and the mistakes made by those in positions of power still lingering in the background today, the words from Alexander Hamilton above are a subtle reminder as to the importance of public debt and the need for its meticulous management. As noted by Stasavage, (2003, p.1) government’s usage of public debt can be a useful strategy to fund budgetary expenditure and liability deficits. Neu, Warsame and Pedwell (1998, p.25) develop that point further when they state that:
“Sound debt management strategies can be instrumental in ensuring financial stability, by creating a liability structure for public debt that sustains low levels of refinancing risk for the sovereign throughout the business cycle and by securing the sovereign’s ability to issue the necessary volume of debt at a reasonable cost in a downswing…”
Therefore, a government will adopt a strategy which is least cost for the funding requirement sought whether for short term urgent need or for forecasted longer term requirements. Essentially a government acting within financial markets can be viewed as both a supplier, e.g. of financial yield bearing instruments to investor and lending markets or purchaser e.g. in obtaining loans at a price (i.e. interest). Economic laws as of supply and demand will operate within each aspect of the above markets.
Section 2 – Debt Management: Supply Demand & Elasticity
Price and Quantity are key factors which affect the demand both for funding and supply of govies. For example, if there is a surplus of public debt instruments (more funding being sought than is available) being offered to a financial market, the cost of borrowing (interest/yield rates) will increase. In such a case the government is a buyer competing with other governments and borrowers in financial markets.
Where there is a scarcity of public debt (govies total value at a given point in time amounts to less than the available funding total) being offered to financial markets, the cost to borrow (price of a loan) will reduce financial markets and investors compete against each other to reduce availability of public debt offerings. In such a case while a government is still buying debt, but due to the scarcity of govies and where it is perceived as low risk borrower, the government may also act as a supplier where demand funding for stable government debt instruments (govies) is greater than the value of the debt sought and offered by low risk, stable governments.
Elements of price elasticity, in the form of interest rates for govies, can affect the management of public debt. As listed in Lecture 2 of this economics course (Elasticity & its Application), there are range of determinants of elasticity:
- Close Substitutes: i.e. other equal or higher credited sovereign debt govies, national infrastructure projects which provide revenue streams; precious metals
- Broad v. Narrowly Defined: Govies are very narrowly defined instruments. Price elasticity will take effect when other factors outside of price and quantity come to play. Mankiw, (2015) notes that there are number of demand and supply curve shifting factors which impinge on suppliers and buyers of govies. Mankiw utilises the perfectly competitive market (i.e. where there so many suppliers and buyers that neither can affect the price), to illustrate these factors. (see Appendix 1 for summary of these factors).
- Long Run v. Short Run: Price elasticity is higher in the long run than the short run, where governments can switch to different funding sources or rebalance their debt profiles to include more revenue generating investment projects and options.
Section 3 – Debt Composition: Pros & Cons
As discussed above, there are several demand, supply and market factors which need to be considered by a Government when engaging with public debt management. When considering these factors in the decision-making of the type of debt instruments to offer and to which they may commit, we can look at it from a short-term & long-term view.
Short-Term Pros and Cons
#1. Negotiation Position:
May be blended and bundled with other debt as a strategy to improve negotiation position in order to reduce interest & repayment obligations #1. Cost:
More expensive because the government is perceived as less competent, therefore perceived as a greater lending/investment risk.
#2. Emergency Scenarios:
A stronger economy and government, who have debt servicing and sinking funds reserve built for emergency scenarios (e.g. weather damage). #2. Number of Buyers:
During global or regional recession or depression, there tends to be fewer available buyer-lenders.
#3. #3. Repayment:
Less predictable repayment, containing more uncertainty risk even with a shorter-term duration.
Long-Term Pros & Cons
May #1. Credit Risk
Liabilities left on the Government public accounts over longer terms, may lead to increased credit risk perception by lenders
Valuable assets could be left as collateral on loans
#3. Tax & Cost:
Spending capacity could be reduced and possibility of pressure to increase taxation
When looking how Ireland fares in terms of national debt compared to countries listed in the Central Government Debt Securities excel we can see immediately that
Appendix 2 (A) contains a table which shows the composition of national debt for Ireland over the past 2 years. Although total national debt was stable between 2016 and 2017, there was a noticeable increase in of roughly €5bn as at October 2018 which we can see in table (B) suggesting that our national debt is increasing at a significant rate.
Government bonds and short-term debt were the key drivers for this increase in national debt. As mentioned by O’Brien (2018) in his article on Irish public debt, this is the tenth year in a row that Ireland has had a deficit.
When comparing current national debt of ~€190bn to the ~€50bn we had back at the beginning of the last recession, it is almost incomprehensible to envisage what we would have endured during the last 10 years had we the level of public debt that we currently have.
Although there have been several occurrences in the past few years which should have aided in seeing Ireland out of the red and into the black, in the form of 1. unexpected corporation tax received and 2. lower cost of printing money thanks to the ECB, Ireland have managed to spend these unforeseen incomes rather than utilising them to manage national debt efficiently (O’Brien, 2018).
Section 4 – Revenue Maximisation: Auctions
With all this debt accumulating, governments need to efficiently balance it with a steady stream of income, which can come in the form of auctions. There are two methods that can be utilised with the end goal of increasing the revenue yielded – Dutch Auction and Discriminative Auction. Both involve the selling of securities in a public offering however, they vastly differ in terms of the style in which the price of said securities is determined.
On one hand, we have a discriminative auction which is the more traditional method in which people would be accustomed to. A bid of a certain price or yield is made, and that price or yield is what is given. There are no surprises. As mentioned by Friedman (1991), this can be a clever way for governments to increase their takings when bids with a price above asking price are offered.
However, the drawback to this is that there is the possibility of colluding investment specialists that may receive the tenders because they have the advantage in negotiation power, which can lead to a distortion and manipulation of the true market price.
On the other hand, we have a Dutch auction which is almost counterintuitive to the discriminative auction as bids are decreasing in value as the auction carries on with the lowest offer winning, thus setting the price or yield all will pay regardless of others initially bidding a higher figure. Typically, before Dutch Auctions were introduced, the government had uncertainty, reduced negotiation power and risked suboptimal prices and value for the quantity of bonds sold. In this method, they will be able to ensure that most, if not all, the securities would be sold as the price is fair and not overstated.
When the government needs institutional and external sources of debt funding Friedman suggests: “Sell all securities exclusively by auction so the market can set the price” Friedman (1991). Should I be overseeing the issuing of government securities, I would agree with Friedman and opt for the Dutch auction as more than likely, all securities will be purchased along with encouraging the success of future auctions Overall, it appears to provide better planning control, market protection, optimised valuation of bonds offered; and price establishment by the issuing government.
Section 5 – Conclusion
When it comes to public debt there is a fine line between great fortune and financial misery for a country, so it is important to keep a close eye on what and how much we are spending. When looking out the window of offices and buildings, not only around Dublin but many cities throughout the world, at the multiple cranes that are littering the horizon, one could almost assume that the boom is on the verge of arriving back with a bang (if not already landed).
However, there is still a compelling need for the government to have its head firmly in the game when it comes to public debt management and not spend unscrupulously.
Although public debt is an effective way in which governments can manage the deficit between revenue and spending, there is a fine line between what could make a country prosper or make a country fall to its knees. There is a dutiful need for those in government to ensure that national debt does not go beyond what the country is able to manage, and that the future of our country isn’t poised in position for another harmful economic downfall like that in recent memory.
This assignment has highlighted methods in which those in charge of managing public debt can utilise to ensure the following generations can live in a country that has a national debt that isn’t harmful to the progression of their country. This is the basic premise for which I conclude this assignment in the words of Herbert Hoover:
“Blessed are the young for they shall inherit the national debt”