Public finances: Twin deficits | Economy

The President of the Government, Pedro Sánchez, yesterday in Malaga.JON NAZCA (REUTERS)

By accounting convention, a country’s foreign deficit is equal to the difference between investment and aggregate savings. And savings, in turn, can be divided into private savings and public savings. Therefore, holding everything else constant, an increase in the public deficit worsens the external deficit. This is always the case, but after the stagflation of the 1970s, central banks had to raise rates sharply and there were several debt crises. The current raw materials is having the same effect. The producing countries have a strong increase in their foreign surplus and the consumers, like Spain, have a deficit.

In January and February of this year, the trade deficit of goods abroad in Spain was 10,775 million euros. In those same months of 2020, before the pandemic began, the deficit was 5,625 million. The crisis in Ukraine has aggravated the problem and the deficit will continue to increase in the coming months. On this occasion, Spain starts from an external surplus in the last decade, and is within the euro with a credible central bank.

However, our net external debt, although it has decreased from 100% in 2010, is still close to 80% of GDP and is one of the highest in the world. In 2010 the main problem was private debt, this time it is public debt. Until now, the main financier of foreign debt has been the European Central Bank, but it has just announced that it will stop buying debt from countries in September.

You always have to be very cautious with public finances, but in a raw material crisis with very high public debt, much more so. Increasing public spending or reducing taxes increases the public deficit, the external deficit and puts more pressure to finance the debt. The external balance will be achieved with higher interest rates. The ECB has already announced that there will be rate hikes, but not when, and anticipates that it will be very gradual. In the seventies, with the peseta, interest rates skyrocketed with inflation. Higher rates curbed business investment, job creation and lengthened the unemployment rate, which did not fall below 20% until 1987.

The ECB sets rates for the entire Eurozone and then investors set the risk premiums for each country and each debtor. Feijóo’s new PP, at his recent meeting in Moncloa, spoke of deflating the personal income tax rate and lowering VAT on gas. Deflating the rate is not lowering taxes and would have a minimal impact on revenue. And lowering the VAT on gas would have to be negotiated with Brussels and would not have an excessive impact either. But the rhetoric is reminiscent of Rajoy’s campaign in 2011. He promised to lower taxes and raised them all for us, with half the public debt now. We will see.

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