The Inaugural BCAM Policy Talk: “Fiscal Buffers, Private Debt and Stagnation: The Good, the Bad and the Ugly” by Giovanni Melina

This post was written by Veronika Akhmadieva,  an MPhil/Phd Economics student at Birkbeck

One group is targeted for marketing outreach with a bulls-eye under the figures

In 2015, global debt hit a record high of $152 trillion (225% of world GDP), raising the possibility of a new global financial crisis striking the economy in the near future. That prompted the International Monetary Fund (IMF) to conduct an in-depth analysis of global debt and economic growth. The results of this research formed the basis of the inaugural BCAM (Birkbeck Centre for Applied Macroeconomics) policy talk at Birkbeck, given by Dr Giovanni Melina (IMF).

Dr Melina presented an academic paper, a result of his joint work with Nicoletta Batini (IMF) and Stefanie Villa (KU Leuven), that focuses on fiscal buffers, debt and stagnation, and has strong policy implications. In the period from 2002 to 2008, the bulk of the increase in debt of large advanced economies was due to borrowing by the private sector. Then, as some might recall, the Great Recession happened, and the picture changed dramatically; the increase in private debt was rather modest while government debt increased drastically.

A curious mind might wonder why government debt went up during the financial crisis 2007-2008. Dr Melina proposed two possible reasons. The first explanation is based on the denominator effect and on the mechanism of government automatic stabilisers. Government spending, in nominal terms, increased during the financial crisis, partially because more people applied for unemployment benefits, and this in turn boosted government debt. The second explanation derives from the fact that many governments attempted to cover part of private debt – through the recapitalisation of banks, for instance – and that led to the fall in government revenues and the rise in public debt.


The deleveraging is a well-known concept in economics that refers to the process of economic entities reducing their debt to income ratio. The deleveraging of the economy often follows global economic catastrophes, and the financial crisis of 2007-2008 was no exception. Deleveraging can yield important real effects in the economy. Advanced economies can resort to public debt to a very large extent in order to cushion the effects of the negative shocks. For emerging markets raising government debt can be tricky. In some of them deleveraging is still to take place. So what are the best ways for governments to tackle potential deleveraging?

Dr Melina might just have the answer. But first two preliminary questions must be considered – do the levels of private and public debt have tangible effects on output growth? And should government extend financial assistance to credit-constrained agents and firms at times of financial distress?

The paper addresses these questions by first revisiting the literature on the effects of public and private debt on economic growth. Then the authors build a theoretical framework that reproduces the leverage cycle. The authors examine links between private and public debt, in order to capture the mechanisms through which private debt may become public. Finally, the model is used to analyse the effects of government interventions targeted towards financially constrained agents.

Private debt proved to have a negative effect on output. As for public debt, when authors differentiated between high (greater than 95% of GDP) and low public debt countries, they found that when the public debt is low, the government has more room for manoeuvre (more fiscal buffers) and can help to support economic activities in the deleveraging phase. However, if the level of public debt is high to begin with, the further increase is detrimental to the economic growth.

On the question of government financial assistance to credit-constrained agents, it appears that intervention mitigates the extent of the deleveraging and reduces the deflationary effect of the negative house price shocks. Another somewhat counterintuitive finding is that the peak increase in government debt is decreased by government intervention; if government intervenes, it sustains the economic activity and by doing so it reduces its debt. If the level of inefficiency of government spending is high or the level of intervention is excessive, the above may not be true. According to Dr Melina – with about 10% inefficiency costs, the optimal size of intervention is about 7-8% of GDP.

Targeted Intervention

One step further, the authors compare the policy of targeted intervention with other types of fiscal stimuli, such as government investment and government consumption. They found that targeted intervention is more effective in the deleveraging phase, as it is aimed at financially constrained individuals that have high marginal propensity to consume. Hence, most of the funds that are channelled towards these individuals are consumed and that translates into a stronger output effect. Some economies, such as Southern European countries, have limited fiscal space to begin with and can only intervene to a very small extent. These countries may benefit from using limited government funds for targeted intervention rather than increasing the general level of government spending, which might be a less efficient option.

Targeted intervention works best if adequately planned and complemented by appropriate monetary and fiscal policies. In addition, it can be direct, meaning targeted at firms and private sector, or indirect, through banks, recapitalization, asset purchases and guarantees. When banks are in distress, direct targeted intervention might be preferable, because banks may use the funds provided by the government to repair their balance sheets, instead of increasing lending to the private sector.

In practice, targeted intervention might not be the easiest task for governments, as they have to find a way to discriminate between agents, to provide funds to specific firms or industries. Targeted intervention naturally raises moral hazards and competition issues, too. Dr Melina emphasised that targeted intervention is not something to be practised by the government on a regular basis, but should be reserved for disastrous times, when the economy is in distress and in urgent need of stabilisation policies. Could it be that now is just the right time?

Further information:

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Understanding the European financial crises: Martin Sandbu at Birkbeck

Martin Sandbu, the economics leader writer for the Financial Times (FT), was the special guest at a recent talk at Birkbeck on 19 February. This event was organised under the auspices of the Birkbeck Politics Department’s MSc programme in European Politics & Policy in association with Birkbeck’s Departments of Management and Economics, Mathematics & Statistics.

As one of the UK’s most influential UK economics commentators, Martin provided his insight into whether Europe’s economy has turned a corner, and whether the Eurozone’s fragile recovery is sustainable. Here, Charles Shaw and Ahmed Razzaq of the Birkbeck Economics and Finance Society report from the event

In a recent talk at Birkbeck, FT’s Martin Sandbu located the economic failure of the Eurozone in institutional arrangements and policy choices that laid the basis for organisational deficiencies.

Financial Times columnist, Martin Sandbu

Financial Times columnist, Martin Sandbu

During the Eurozone crisis, the message from European policymakers was abundantly clear: that the euro fostered many of the recent problems, or at least was a strong contributor to the high budget deficits at the heart of the crisis, and that there was no alternative to the bailout packages. Subsequent large transfers from Germany to the debtor countries were therefore justified along these lines, in exchange for harsh austerity, overly tight monetary policy, and structural reforms.

In his new book – “Europe’s Orphan: The Future of the Euro and the Politics of Debt” – Martin Sandbu perceptively argues that this accepted orthodoxy is in fact at odds with history and evidence from the period. Nothing is wrong with the euro itself, he suggests. It is rather the policies of the governments of the Eurozone and the European Central Bank that were and are wrong. If true, what implication does this have for our understanding of the wider economy and the implementation of policy initiatives? Further, what can we expect in the short to medium term, given the costly spillover effects of a sustained drop in energy and commodity prices, and revived fears of a new recession in advanced economies?

BNP Paribas recently noted that last month was “the worst for risky assets for many years, if not on record.” Given this current affairs backdrop – of a recently announced date for the UK’s referendum on EU membership, and extremely negative levels of sentiment and investor positioning – Martin’s talk on the politics of Eurozone debt could not have been more timely.

Dispelling some of the post-crisis myths

European Central Bank in Frankfurt (Image copyright Eoghan OLlonnain via Flickr)

European Central Bank in Frankfurt (Image copyright Eoghan OLlonnain via Flickr)

On the evening, Sandbu lucidly examined the case for the Euro, not by focussing on virtues of a single currency, but focusing instead on the failure of European macroeconomic policy and in particular the inflexibility of the European Central Bank, European Commission, and Member State Governments to allow for restructuring of private, and later sovereign, debt.

Many analyses of the crisis blamed an unholy trinity of weak financial regulation, ineffective supervision, and profligacy on the periphery. Sandbu was able to provide an important corrective to such gross simplifications and dispel some of the post-crisis myths by pointing out, for example, that profligacy was not at the core of the problem. With the exception of Greece, the economies that had to resort to bailouts were not those with the highest debt-to-GDP ratios.

This and other forms of evidence allowed Martin to convincingly make a nuanced case for the Euro being more of a scapegoat than catalyst in this affair. If there was a smoking gun in the run up to the crisis then, Sandbu argued, it was not the Euro per se. He went further, stating that the sovereign debt crisis would have likely occurred without the single currency due to the magnitude of nominal rigidities observed at macro level, incomplete institutional infrastructure, and the fact that Eurozone governments that ran into trouble had no lender of last resort.

When questioned on whether he would agree that a more centralised Europe would be better able to cope with these issues in the future, Sandbu would not be coaxed. Whilst sceptical of the utility of European fiscal and political union, Sandbu did identify efforts made in establishing Eurozone equity markets as conducive to heading off some of the risk of a similar debt crisis in the region going forward.

The ‘liquidationist’ alternative

If there was one take away from the evening it is that the Euro may not have caused the crisis but the main actors, in dealing with the crisis, compounded the severity of events. In what Martin Wolf described as the “liquidationist” alternative, Sandbu made the case for restructuring of debt and a softer landing, albeit with the pain of haircuts for bond holders.

This was a point of view recently echoed by Professor Lord King, Governor of the Bank of England throughout the period, who, in a recent talk at the London School of Economics, supported Sandbu’s call for a restructuring of Greek debt as the only way out of a Depression that he could not fathom getting so out of hand in the post-war period, let alone in the twenty-first century.

Sandbu is not a lone voice on this issue. Others, such as Ashoka Mody, the former IMF bail-out chief in Europe, have argued that ECB not only failed to provide stimulus to the Eurozone economy when needed, but, as a result of an apparent battle between political will and economic arithmetic, allowed it to slip into a “low-inflationary trap” (i.e. a negative feedback loop where inflation is dropping because the economy is weak, whilst the same economy being weakened by falling inflation).

According to Mody, the fact that ECB allowed the Eurozone to slip into such a predicament is a reflection of the monetary union’s faulty architecture. Such comments echo Milton Friedman’s infamous 1997 letter to The Times, which suggested that the economic foundations for the Eurozone are built on sand, and that the demise of the euro is possible, if not probable.

The Eurozone crisis appears to be in remission. However, with the expectation of a U.S. Federal Reserve interest rate rise, combined with the possibility of global shocks due to China’s rebalancing, the Eurozone cracks look set to increase in prominence. Martin Sandbu’s timely analysis is carefully defined, clearly presented, and one that serves as an important contribution to the current debate. His book, “Europe’s Orphan”, should be required reading for anyone seeking to understand the European financial crises, and is a sophisticated and accessible insight on an otherwise too commonly obfuscated and misrepresented topic.

Further Information

The School of Business, Economics and Informatics will hold an Open Evening on Thursday 14 April 2016. Find out more

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Keeping students competitive

This post was contributed by Charles Shaw, founder of the Birkbeck Economics & Finance Society

Students at the Venture Capital Investment Competition (CM 2016. All rights reserved)

Students at the Venture Capital Investment Competition (Venture Capital Movement or VCM 2016, All Rights Reserved)

The best thing about studying in London, apart from the outstanding education options, is the sheer number of opportunities to expand one’s professional network. This is particularly important for those students seeking careers in finance or professional services, where tens or even hundreds of applicants are often chasing the same job.

As many students are no doubt discovering, an excellent academic record is necessary but not sufficient as employers often want relevant work experience and excellence in an extra-curricular activity. Internships are also rare, making it at times particularly challenging to obtain practical experience and to gain relevant insight in one’s chosen future industry.

With this in mind, Birkbeck’s Economics & Finance Society enters student teams into select competitions, with the hope that preparation for and participation in such contests augments their understanding of financial concepts, and sharpens their technical skills in preparation for the challenges of the job market.

Last month, the Society entered a team in the Venture Capital Investment Competition (VCIC). This event, supported by the British Private Equity & Venture Capital Association, is designed to simulate the analysis, preparation, and delivery that private equity and investment professionals engage in when evaluating risk-return trade-offs and executing exit options. Taking place over the course of one day, students from multiple disciplines have the opportunity to test their understanding of the praxis of corporate finance against top teams from other universities.

About the competition

Although this marked the first time that the competition took place in London, VCIC enjoys a strong tradition of participation in United States. The original Venture Capital Investment Competition began at UNC Kenan-Flagler in 1998 as an educational event for MBAs to learn about venture funding.

The format has largely remained unchanged. Experienced investors act as judges and students have the opportunity to interact with actual entrepreneurs to analyse capital structure of young firms and decide potential investment opportunities; students work in teams to conduct due diligence, look through topical, complex business problems and present valuation, investment analysis, and relevant proposals concerning syndication, option pools, and anti-dilution measures.

VCIC in London

The event had a strong London flavour to it as a number of the capital’s institutions were represented. Eight teams were participating in total, with students from LBS, LSE, Queen Mary’s, UCL, King’s, Cambridge and Birkbeck. The event received wide coverage in diverse international media, including outlets in United States and Singapore’s The Straits Times reflecting the London’s international workforce and diverse student population. In addition, all of the participating start-ups were London-based technology companies, reflecting the capital’s vibrant network of tech hubs.

The competition was organised under the aegis of UCL School of Management, and served as a both a training ground and a marketplace. On the one hand, future finance professionals were able to learn a great deal about technology commercialization and investment due diligence by working with owners of actual start-up companies. On the other hand, students were able to engage with the full spectrum of entrepreneurial activity, from a company’s planning and execution strategy, to the due diligence process for potential investments. In turn, firms’ owners benefit from students’ management insight and strategic recommendations they otherwise might not obtain.

Although the competition is new to London, it enjoys a strong tradition of participation in United States. Indeed, the event, which originated in North Carolina in the midst of the technology bubble as an opportunity for graduate students to learn about venture funding, is now in its 18th year. As a result of this tradition, the winning team, LSE, was invited to take part in the VCIC International Finals at UNC Kenan-Flagler in North Carolina, United States.

Deepening understanding of financial processes

2 VCM 2016. All rights reservedDuring the competition, students were able to deepen their understanding of the links between potential investors and business owners. Such links include, for example, both the explicit contractual arrangements between entrepreneurs and venture capital providers, and the implicit contract which gives a successful entrepreneur the option to reacquire control from the venture capitalist by using a floatation as a means by which the venture capitalist exits from an investment. Students were also able to gauge the viability of alternative forms of investment such as acquisitions, alliances, and licensing.

The company evaluation case-studies provided up-to-date and real-life corporate finance challenges that offered participants practical experiences in the field of financial services. Overall, the competition was an opportunity to interact with students from other top academic institutions, to immerse in a global business context where competitors are potential partners, and to become familiar with the challenges of managing a company.

The importance of gaining field-based knowledge

Was it a valuable experience for participants? Without a doubt, yes. Students of investment have long been interested in how firms can achieve growth. In this vein, a long tradition of scholarship exists on the various tools that firms can employ to pursue financial growth and corporate development. While there are extensive opportunities available for learning about various means for business development and corporate growth, both at undergraduate and graduate level, there are relatively few opportunities for students to augment the entrepreneurial concepts learned in lectures and seminars with practical field-based knowledge. There are even fewer opportunities to solve realistic business problems with a corporate finance focus under the direct guidance of senior M&A practitioners, industry experts and company directors.

It is hoped, through the continued engagement of London’s business and investment leaders, as well as through our academic network, that we can help prepare our society members for job market success. This competition, and others like it, can help understand how business strategy would flow down to operations and to financial performance of a business. It highlights how competition, contracts and external factors dictate business in terms of pricing and quality. It was also an opportunity to integrate appreciation of demand, pricing, legal factors, finance and accounting, and strategy, towards a common goal of financial performance.

The Birkbeck team consisted of: Dimitrios Bissias (MSc Economics), Ahmed Razzaq (LLM), Hannah Duck (BSc Statistics and Economics), and Ved Vyass Boojihawon (BSc Financial Economics with Accounting).

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