From the outside looking in, someone trying to figure out exactly why Standard and Poor’s downgraded Greece and Spain — the former to below investment grade — has only the press releases to go on.Â And from each, it seems clear that the downgrades are driven by the forecasts for GDP, nominal and real.Â
Greece — Under our revised assumptions (see below), we expect real GDP to be nearly flat over 2009-2016, while the level of nominal GDP may not regain theÂ 2008 level until 2017.
Spain — Standard & Poor’s credit analyst Marko Mrsnik said ..Â “We now project that real GDP growth will average 0.7% annually in 2010-2016, versus our previous expectations of above 1% annually over this period.”Â We have also revised our views on the GDP deflator, so that we now expect nominal GDP to regain the 2008 level by 2015; previously, we had assumed that nominal GDP would exceed the 2008 level in 2013.
The projections for real GDP are grim enough but the possibility that nominal GDP — the thing that has nearly always gone up inÂ developed economies since World War II — might not be at itsÂ 2008 level until 2015 (7 years) or 2017 (9 years!)Â is a shocker.Â Whatever about the current level of wages and prices, this would mean revisiting the ingrained assumptions ofÂ annual increases in wages and pricesÂ for the next 5-10 years.Â Not to mention revisting the question of what is aÂ “reasonable” interest rate.Â And most of all, the need for careful use of debt to GDP ratios.Â If GDP isn’t increasing, then any growth in the level ofÂ debt makes the debt burden worse.
Anyway, two other quick thoughts.Â First, S&P presumably excludes the effects of its own rating actions from its forecast.Â But of courseÂ the ratings action itself now appears to be a driver of policy response to Greece’s predicament, if not the actual outcome.Â And second, since S&P’s model is having such wide implications, and appears to be more pessimistic than either theÂ baseline accepted by the European Commission and the IMF,Â shouldn’t the model beÂ made available for scrutiny?Â In particular, the ECB would surely want a look at the inflation projections, since nominal GDP is a variable over which they have some control.