In 1995, after Moody’s downgraded credit ratings in Canada and Mexico, New York Times columnist Thomas Friedman memorably joked: “It can almost be said that we are living in a world of two superpowers again. There’s the United States and Moody’s. The United States can destroy a country by flattening it with bombs; Moody’s can destroy a country by degrading its obligations.”
Twenty-five years later, the joke would be a little different, with China joining the ranks of super-forces. But as the world tries to respond to a fatal and costly pandemic, it is transparent that the strength that punctuation agencies like Moody’s and S-P control liquidity-filled governments is not going anywhere. In fact, in a new encounter with a colleague, I think the scores have never been higher.
To perceive why, credit scores are not arbitrarily decided through credit rating agencies. Rather, they are motivated by a country’s economic prosperity, the quality and stability of its political establishments, and its public debt. And in recent decades, this public debt has skyrocketed.
Among complex economies, the debt-to-GDP ratio increased from around 50% in 2000 to more than 70% in 2019, with countries such as Japan (235%), Greece (179%), Italy (131%) Portugal ( 123%) “as the most sensitive in the package” in terms of public debt. Take, for example, France, which had a debt-to-GDP ratio of 58.9% in 2000 and is now around 100%, or the United Kingdom, which rose from 36.8% in 2000 to 85.9% in 2018. United States, which rose from 55.6% in 2000 to 106.9% in 2019.
Governments and central banks responded to the COVID-19 pandemic and the resulting economic devastation through fiscal and financial teams on a scale never before experienced by the world. For example, the reaction of U.S. fiscal policy under the CARES Act is lately estimated at $2.3 trillion (about 11% of GDP). In Germany and Japan, the fiscal reaction was even greater as a percentage of GDP, reaching 32.9% and 22.0% of GDP respectively.
To fund many of these programs, governments around the world will have to take on more debt, and their ability to do so will depend on money markets.
In a recent study with Nitzan Ben-Tzur of the Kellogg School of Management, I read about the points that shape fiscal and financial policies that have been followed in all nations. Our study shows that around the world, budget spending in reaction to the COVID-19 crisis is considerable: on average, fiscal expenditures (including government-guaranteed loans) account for 7.7% of GDP. For high-income countries, those with gdp consistent with capital above the global median, spending is even higher.
To locate it, we organized a statistical “horse race” among a number of macroeconomic variables such as GDP consistent with the capita, population size, debt-to-GDP ratio, public expenditure relative to GDP, number of Covid-19 instances, and government credit assessment. Of all the macrovarivariables we examined, we found that a variable was constantly presented as the most powerful determinant of fiscal policy: something more powerful than GDP consistent with capital or even the spread of the virus. And that’s what a country’s sovereign credits score before the crisis.
These effects demonstrate that a country’s ability to implement fiscal policies is limited to its credit markets.
Government credit ratings have been greatly affected by this crisis. According to Marc Jones of the World Economic Forum, S-P has already made 19 sovereign rebates, while Moody’s estimates that the virus will increase the debt of the world’s richest countries by nearly 20 percentage points.
But once this crisis has passed, countries around the world deserve to work hard to improve their solvency. It turns out that countries with declining credit ratings cannot make effective use of fiscal policy equipment during economic crises. And after all, you never know when the next crisis will come.
I am Professor Harold L. Stuart of Finance and Director of the Guthrie Center for Real Estate Research at the Kellogg School of Management. My focus on
I am Professor Harold L. Stuart of Finance and Director of the Guthrie Center for Real Estate Research at the Kellogg School of Management. My studies focus on credit markets and corporate finance. I examine debt contracts, currency crises, securitisation, bankruptcy and monetary misery. My paintings on monetary misery and currency crises have been published in major educational journals and have gained extensive media coverage. They gave me my PhD. University of Chicago.