Home > The Economy > What a difference private debt makes

What a difference private debt makes

from Merijn Knibbe

Ireland and to a much lesser extent Spain are in fiscal trouble. The Government deficit as well as the government debt is high – so high that increasing interest on government bonds causes even higher deficits and debt. Was this due to fiscal irresponsibility? No. According to the latest Eurostat update the usual fiscal macro economic data for Spain and Ireland were excellent as late as 2006 and for Spain even in 2007. They did much better than Germany. Look at the next tables 

Table 1. Govenment expenditure, % of GDP, 2006/2009

Germany 45%/48%

Spain 38%/39%

Ireland 34%/49%

Table 2. Government deficit as a % of GDP, 2006

Germany -1,6%/-3%

Spain +2,0%/-11%

Ireland +2,9%/-14%

Table 3. Government debt as a % of GDP, 2006

Germany 68%/73%

Spain 40%/53%

Ireland 25%/66%

What did cause the present problems? The answer is simple: the bust of the housing bubbles in Ireland and Spain. By the way: another interesting aspect of the Eurostat data: as a rule, countries with the highest share of govenment expenditure (% GDP) had the lowest increases in deficit from 2007 to 2009 (countries like Luxembourg and Malta excluded).


  1. TK
    November 17, 2010 at 2:33 pm

    Thank you, Merijn, for pointing this out. Unfortunately, European policymakers (and journalists) have been so obsessed with public debt that simply ignored debt in the private sector. They continue to do so despite the obvious fact that it was private, not public, debt that caused the Great Financial Crisis and so on. The obsession with public debt, and the associated neglect of private debt and trade imbalances, has done great harm to the European project and will ultimately lead to the collapse of the Eurozone.

  2. merijnknibbe
    November 17, 2010 at 2:35 pm

    Table 2 and 3: 2006 should read as: 2006/2009

  3. John Laffon
    November 18, 2010 at 6:11 am

    Are you perchance saying that because of the collapse in banks’ balance sheets and people’s networth, due to the fall in house prices, that economic activity has been subdued, tax revenues have fallen, that fiscal expenditure is now harder to fund?

    Oh I think I see, so basically your arguing that if the government took up a bigger part of the economic pie that the ‘free market’ would less be able to damage itself?

    Please give more detailed background analysis or explanation if I am mistaken.

  4. John Laffon
    November 18, 2010 at 6:15 am

    Just to alter the tone a little, I am merely trying to understand better as my knowledge is limited and am get a better understanding of the issues at hand :-)

  5. merijnknibbe
    November 18, 2010 at 1:40 pm

    “It might seem to banks that they can save money in the short run by increasing the volume of loans faster than personnel are hired to oversee the loans’’

    Mason McGaffney, 2009.

    What happened?

    It’s about like this (but please, read the Georgist Mason McGaffney about this)

    1. Houses have a ‘use value’ and an asset value’. People need shelter, they want a home – but at the same time, a house has a lasting monetary market value – it’s also an asset.
    2. We’ve had a housing bubble. For banks and individuals alike, a speculative asset motive started to dominate the ‘use value’ motive. People wanted to buy expensive houses and could obtain easy credit because everybody expected that the asset value would go up – and not because they wanted a decent and affordable place to live.
    3. Mortgages became ever more important on the balance sheet of banking and in countries like Spain, the USA and Ireland, construction became an exceptional large part of the total economy. Governments also became dependent on income from selling land – that’s one of the reasons why Ireland and Spain had a government surplus! Increasing income from land might also have led to a neglect of the tax base of other taxes, but I’m not sure about that one.
    4. So, we have three problems:
    a. ‘Inflated’ mortgages on the balance sheet of the banks
    b. An inflated construction sector in the economy
    c. Government income wich was to an extra-ordinary extent dependent on selling land or rights to land
    5. On top of this, there was the (for most of us) unexpected economic downturn of 2008
    6. Now, the bubble bursts. That leads to direct effects:
    a. The construction sector decreases sharply, leading to unemployment, less taxes and more welfare spending
    b. Land related income, like all kind of fees as well as income from selling land, decreases.
    c. House prices decrease
    d. Because of the crisis, there also is widespread unemployment outside the building sector, leading to less taxes and more welfare spending
    e. Equity of house owners decreases.
    f. Some of the house owners have to sell at low prices (divorce, death, other job and other live events). Many unemployed can’t pay their mortgages anymore and are foreclosed.
    7. The result: government deficit and bad banks.
    8. Capital markets loose confidence and want higher interest which cause projected government deficits to spiral out of control.

    Now comes the part which I do not understand: the banks are compensated for the bad loans, leading to even more government debt and even higher interest rates. But the banks are not forced to write down on their loans or to charge less interests from their customers. The Irish people now have to pay their mortgages as well as the government debt. It is as if a loan in silver has to be paid back with gold coins of the same weight. Even ‘The Economist’, not really a left wing periodical, calls for action (from shareholders) to oblige banks to use bonus money to strengthen the balances… The ECB can do IQE (Irish Quantitative Easing), charging the irish by the way quite a bit more than the banks. Somehow we have to stop the paradox that, when prices of houses drop, ever more houses become empty and ever more people are foreclosed. Anybody an idea? I mean, it can happen to Spain and The Netherlands (the country with the third biggest housing boom, according to Eurostat) too.

    Click to access Great_Crash_of_2008.pdf

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