What if it was the US sovereign debt the next big unknown to explode on the financial markets? The alarm bell was activated by the economist Thomas Monacelli, professor of Macroeconomics at Bocconi, on the achievement of the so-called "debt ceiling” (debt ceiling) in the USA. A constant in American public finances, given that the maximum debt limit with stars and stripes was raised 44 times in the past. “This time there are potentially incendiary economic elements. The fiscal policies of first Trump and then Biden have put US fiscal policy on a path that leaves a lot of uncertainty. Uncertainty about "if" and "when" public debt will be stabilized in the future. Market expectations could easily turn towards distrust, such as to no longer expect them in the medium to long term debt stabilization».
Meanwhile, data on the US economy continue to score positively: in the fourth quarter it grew by 2,9%, above the estimates which predicted a +2,6%. «The risk is that the dispute over the "debt ceiling" will become a focal point for the financial markets, exactly as happened in Great Britain with the triggering of distrust of the fiscal policy of the Liz Truss government. A can Armageddon for the markets».
Professor Monacelli, what are the chances that the "debt ceiling" will translate into a concrete risk for the American economy?
«It is a tail risk, it is not so imminent. Looking ahead, however, the question of debt stabilization could become the first problem of the American economy. The fiscal situation is a time bomb, for years there has been an expansion of the deficit and debt but no Administration has the courage to get their hands on it. With this inflation, however, it is no longer possible to think of not touching the tax lever".
And what would be the cascading risks for the rest of the financial markets?
“It is clear that a crisis of confidence over US sovereign debt would immediately spill over into the world. The future of American debt is completely in the dark, not even Joe Biden has taken a clear position so far. How will the markets direct their expectations if no one is able to envisage a path to debt stabilization».
The inflation factor also plays on the debt stock. What is the Fed's most up-to-date vision for managing rising prices?
«Traders' perception is that inflation in the US could fall faster than expected. They predict a "soft landing" on the ground towards a recession. Therefore, there is room for further rate hikes. On the FED front, however, it is not yet clear what inflation is tolerable in the next 2-3 years».
It is true that, compared to previous inflationary seasons, the new global variables to put together make monetary policy choices even more difficult.
«It certainly makes no sense to compare the great inflation of the 20s with this economic phase, two different worlds. At the time, they didn't even bother managing what we now call market expectations about inflation rates. In the last XNUMX years, however, the theory of expectations has become the center of all reasoning».
In any case, there is a communication part of the central banks that hasn't worked very well in the last year.
«The truth is simpler: the FED and the ECB made big mistakes, they spoke of temporary inflation when it was clear that it was instead something far more serious. Even though there were still many useful lessons in monetary policy available starting from the experience of the XNUMXs».
Central bankers' communication and market expectations: did the first short-circuit on post-Covid inflation start from here?
«The FED in a short time has implemented a sensational change of communication to try to re-orient the expectations of the operators. He corrected the course a bit, but in general his communication attitude was surprising and disappointing at the same time».
But what is your analysis on the persistence and structure of US inflation?
«The cyclical component, ie the one influenced by energy and oil prices, is not very relevant. Instead, there is a trend of persistent inflation originating from strong domestic demand. The problem is that from Trump to Biden there has been no cooperation between fiscal policy and monetary policy".
The famous dilemma between a recession and a soft increase in interest rates, what direction is it taking?
«Interest rates will rise, the expected recession seems less strong and even no longer safe. One fixed point remains: we are living in a persistent inflationary phenomenon and in these cases inflation generally stays on for a long time. Surely in the USA as long as the fiscal issue remains unresolved there will be no alternative to high inflation».
In Europe, inflation is of a different order than in America...
«The origins are different, in Europe the energy issue helps to push prices. But one must realize that when inflation becomes very pervasive the root causes lose importance. Through the mechanism of market expectations, the fact that inflation has been generated in one way or another does not change the substance of things. Moreover, even in Europe there is no coordination between monetary policy and fiscal policy".
Strong and probably unexpected criticisms of the ECB have come from the Italian government.
«In Italy there is very high inflation, over 12%. We have a torn fiscal framework and uncertain sovereign debt policies. However, let us remember that the markets do not consider our debt as reliable as the American one, despite the problems of the "debt ceiling". Politicians should know that interest rates are currently just above the neutral rate. So, as much as we tear our clothes here in Italy, the rates are still low. And there is still a lot of room to raise them».
What did you think?
«They are taking incredible positions. Of course, with Mario Draghi in government, no one imagined criticism of the ECB. But it is incredible that what the ECB has done for Italy from the sovereign debt crisis onwards is not recognized and praised. The ECB has always protected Italy in an unquestionable way, which is why these criticisms make us smile».
It is conceivable that from now on stable orders will arrive from above to avoid taking positions directed against Brussels and Frankfurt.
«With this inflation, among the highest in Europe, Italy would need even higher rates. Other than "clucking" against the ECB, especially when rates are a few basis points above the neutral rate".
In the Eurozone could this powerful inflationary season reactivate a renewed desire to rethink a common fiscal policy? Or anyway to convergence maneuvers?
“It's amazing that no one talks about it. The debate on fiscal policy in Europe has completely run aground. Now there is war, but in the next few years it will be the key theme on the Brussels agenda. It would have been very useful for Italy to have Mario Draghi in charge in such a scenario".
