Government debt consists of the outstanding bonds loans and credits owed by public budgets (federal, Länder and municipalities), as well as by statutory social insurance schemes.
Public budgets are governed by similar rules to private households: should revenues not be high enough to cover expenditure, loans have to be taken out. Apart from other options such as the sale of assets, new borrowing is the only way for a state to access liquidity in the case of a deficit. Public debt can be divided into external debts i.e. debts in a foreign currency, and internal debts i.e. debts denominated in domestic currency.
In addition to the public debt quantified in official statistics (explicit government debt), reference is also often made to implicit or undisclosed government debt. This form of government debt arises in those social insurance schemes, which are financed via the contribution procedure, i.e. in pensions and nursing care insurance in particular, but also in health insurance. Due to the contributions that have already been paid in, contributors have an entitlement to benefits vis-à-vis the social insurance system, which can be compared to the redemption claim of a government bond holder. That is why the cash value of this benefit entitlement is referred to as an implicit debt. Naturally all entitlements that constitute open or implicit government debt are ultimately covered by the payment obligations of a state’s citizens. However, since the term ‘debt’ refers to a state’s gross obligations, the claims of the state on its citizens are not deducted in the debt calculation. [1] In many countries implicit government debt far exceeds the statistically reported explicit government debt.
Public borrowing as an economic and stabilising policy instrument plays an important role as a buffer for cyclical fluctuations (deficit spending). This is the case if the government borrows money to compensate for weak demand on the part of companies and households due to economic conditions and to boost the economy. Examples of such borrowing are provided by the so called economic stimulus package I approved by the German Federal government in November 2008 and the economic stimulus package II approved in January 2009, to offset the impact of the international financial crisis on the real economy (see ifo Schnelldienst, 2009). On the other hand, public borrowing can lead to declining growth at the expense of future generations (Aggregate Investment Approach, see Musgrave 1959, Modigliani 1961, Vickrey 1961) since public borrowing leads to a decrease in private investment. This means that the next generation inherits less public capital than it would have done without the burden of debt.
The subdivision of net new borrowing into cyclical and structural borrowing is also important. The structural deficit shows the size of the public budget’s longstanding financing gap and poses a threat to economic stability, while cyclical deficits arising in weak economic phases disappear during economic booms.
To remain able to take action, a country should keep its debt ratio as low as possible.[2] In a context of rising default risks and interest rates, a country may otherwise be unable to pay the interest on its debts and will only grudgingly be granted credit by the markets. In extreme cases this can lead to the insolvency of a state (sovereign default).
The stability and growth pact therefore stipulates that the debt of EU countries should be lower than 60% of GDP.[3] This criterion is respected by less than half of all EU countries. According to statistics released by Eurostat on 4 January 2012 the debt ratio of 14 EU countries had already exceeded the 60% mark by the end of 2010, led by Greece with a debt ratio of 144.9%, followed by Italy with 118.4%.
In many countries, including Germany, government debt has continued to increase substantially as a result of the financial and economic crisis. According to the German Federal Statistics Office ( press release of 30 November 2011) Germany’s public debt totalled 2,011.5 billion euros at the end of 2010, representing a debt ratio of 83.2%.
The fact that borrowing is an easy way of accessing financial resources, while its costs are not incurred until later, makes it a popular political instrument. That is why national and international rules on borrowing are necessary. There is a legal limit to the level of fresh public borrowing in Germany, for example (Article 115 GG, see structural deficit, FN 1, 2 and 3). This rule constitutes the so called debt brake, which should limit federal net borrowing as of 2016 to a combined maximum total of 0.35% of GDP and completely prohibit net borrowing by the Länder as of 2020 Meanwhile other EU countries have written similar rules into their constitutions. On 9 December the state and government heads of the EU countries (with the exception of Great Britain) decided to introduce a constitutional debt ceiling for all countries in the Eurozone (EU fiscal compact). This stipulates that the structural deficit of the general government should not exceed the upper ceiling of 0.5% of gross domestic product.
[1] The funding shortfall in the social insurance systems is calculated using econometric simulations. The latter are based on the tax revenues and expenditure of a base year accompanied by a mid-term outlook and assumptions regarding future interest rates (see Werding and Hofmann 2008; Moog and Raffelhüschen 2011; Werding and Hener 2011).
[2] According to a study by Reinhart and Rogoff (2010) a country has reached the limits of its load-bearing capacity as of a debt ratio of 90%.
[3] Public debt is measured by the absolute debts of a state, by the interest burden quota, which indicates how high the percentage interest rate payments are in relation to the total expenditure of an economy, or by the debt ratio, which indicates the relationship of state debt to gross domestic product.
Federal Ministry of Economics and Technology and Federal Ministry of Finance document on "Beschäftigungssicherung durch Wachstumsstärkung" (Konjunkturpaket I)
German Federal Ministry of Finance document on the "Gesetz zur Sicherung von Beschäftigung und Stabilität in Deutschland" (Konjunkturpaket II)
European Commission document on the "Stabilitäts- und Wachstumspakt“
Draft of the "Treaty on Stability, Coordination and Governance in the Economic and Monetary Union“
Eurostat, "Update: Structure of government debt”, 4 January 2012
Federal Statistical Office, "2011,5 Milliarden Euro öffentliche Schulden in 2010“, press release, 30 November 2011
"Konjunkturpaket II: Was bringen Investitionen in Infrastruktur?“, articles by Ulrich Klüh and Wolfgang Wiegard, Karl-Hans Hartwig, Thomas Bauer, Busso Grabow, ifo Schnelldienst 62 (2), 2009, 3–15 (Abstract / Download).
Modigliani, F., "Long Run Implications of Alternative Fiscal Policies and the Burden of National Debt”, Economic Journal 71, 1961, 730–755.
Moog, St. and B. Raffelhüschen, "Ehrbare Staaten? Tatsächliche Staatsverschuldung in Europa im Vergleich", Argumente zu Marktwirtschaft und Politik 115, Stiftung Marktwirtschaft, Berlin, December 2011.
Musgrave, R. A., The Theory of Public Finance, Mc graw Hill, New York 1959.
Reinhart, C.M. and K.S. Rogoff, "Growth in a time of Debt”, NBER Working Paper No. 15639, January 2010.
Sinn, Hans-Werner, Ist Deutschland noch zu retten?, Econ Verlag, Munich 2003, Chapter 6 (Abstract).
Sinn, Hans-Werner, "Neuer Pakt für Europa”, Ifo Viewpoint 113, 29 April 2010.
Vickrey, W., "The Burden of Public Debt: Comment”, American Economic Review 51, 1961, 132–137.
Werding, M. and T. Hener, Langfristige Tragfähigkeit der öffentlichen Finanzen: Modellrechnungen bis 2060, ifo Forschungsberichte 53, Ifo Institute, Munich 2011 (Abstract).
Werding, M. and H. Hofmann, Projektionen zur langfristige Tragfähigkeit der öffentlichen Finanzen, ifo Beiträge zur Wirtschaftsforschung 30, Ifo Institute, Munich 2008 (Abstract).
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