Public debt cannot be substituted for private debt

- "The argument used to defend the implementation of highly expansionary fiscal policies since the start of the crisis is that private debt must be replaced by public debt since private economic agents are deleveraging. But we saw that this substitution of public debt for private debt came to a halt very fast: as governments reduced their fiscal deficits while the private sector continued to deleverage, some countries found it impossible to finance their fiscal deficits under normal conditions."
- "Admittedly, the increase in the public debt has often gone far beyond the level that corresponded to a replacement of the private debt, but especially for investors, public debt cannot be substituted for private debt, and they therefore refuse to permanently accumulate public debt in their portfolios instead of private debt:
• investors (lenders) need a default risk-free asset; they accept the default risk on household and corporate debt, but not on public debt, which must play this role of default risk-free asset;
• investors (lenders) assess a debt’s solidity by looking at the counterpart of the debt in the borrower’s assets; for households, we are talking about a real estate asset (collateral), even if its valuation has often turned out to be abnormally high; for governments, the debts mainly finance current expenditure or tax cuts, not the accumulation of an asset, and this worsens their quality."

Natixis Flash Economics 451 20100910

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