Debt relations and welfare financing in Finland

The study analyses on debt and debt relations of individuals and the public sector in a welfare state. It characterizes the properties of private and public debt and implicit public liabilities, studies household debt in a life-cycle perspective, assesses fiscal adjustment and determinants of risk premia of public debt in various countries, explores the interaction of explicit and implicit public debt and surveys financial crises and the socialization of private debts.

Our study aims to analyze debt and debt relations of individuals and the public sector of a welfare state. We start by studying the concepts of private debt, explicit public debt and implicit public liabilities. We ask what are the key characteristics of private and public debt and how do they differ from each other. We then study in more detail household debt in Finland. Analysis of fiscal adjustments and sovereign risk premiums of public debt in euro area and other OECD countries provides comparatives aspects. We also study the fiscal sustainability of a welfare state taking into account both public financial and implicit debt and the new EU policy rules. Finally, we consider financial crises and situations where private financial debts have become part of public financial debt. Thereby we study the major determinants of public deficits and debts: large crisis, fiscal adjustment processes, long-term challenges related to population ageing and the EU-rules.

We have divided this overall research project into the following 5 elements.

1. Characterization of private and public debt and implicit public liabilities

• How does public debt differ from private debt?
• How does implicit public debt differ from explicit debt?
• How frequent are deviations from the contractual commitments and what have been their implications?

2. Household debt in Finland: a life cycle perspective

• How is the household indebtedness related to households’ assets and household structures?
• Have households become more vulnerable to various adverse shocks such as an increase in interest rates?

3. Public debts and fiscal policies in the euro area and other OECD countries

• What kind of differences are there in the fiscal adjustment processes between countries in the euro area and other OECD countries?
• What are the long-run determinants of the sovereign risk premium?

4. Explicit and implicit public debt in Finland and EU’s fiscal policy rules

• Can people trust that the implicit welfare state promises, such as pensions or provision of public services are honored also in worse demographic and economic scenarios than are currently projected?
• What kind of interaction of explicit and implicit debt is to be expected in these scenarios?
• How the new fiscal rules of EU should be taken into account, when making choices concerning taxation and the size and scope of welfare services.

5. Financial crises and the socialization of private debts

• Why can private debt transform into public debt?
• How important is the socialization of private debt quantitatively?
• What can be done to prevent this?

These elements complement each other in several ways: The first element provides a theoretical background for the following elements. Household debt is used as one of the determinants of sovereign risk premium in the third element. In addition, some of the results from the third element are directly used as inputs in the sustainability analysis that is carried out in the fourth element. Finally, one output of this project is a book that focuses on policy implications of our research. There we aim at providing policy conclusions that take into account all the different types of debt relations analyzed in these elements.

The project is done with collaboration of Jyväskylä University School of Business and Economics.