The Primary Deficit Sustainability Framework or PDS Framework is a way to monitor public finances and to see whether they are heading into or away from trouble and adverse bond market reaction.
I was reminded about it in James Rickards book, “The Death Of Money”.
The Key Factors In The PDS Framework
The key factors are:
- B = borrowing costs (as a percentage of GDP)
- R = real output or GDP
- I = inflation
- T = taxes
- S = government spending excluding borrowing costs
Real output inflated (R+I) is the nominal GDP which is used in assessing levels of national debt.
Taxes minus spending (T-S) is the primary deficit, the amount of government spending that has to be funded by new debt before allowing for borrowing costs.
This framework lets you assess whether the interest and other borrowing costs are affordable.
Deficits are sustainable if economic output minus borrowing costs is greater than the primary deficit. This means that the economy is growing enough to pay down a little debt.
If (R+I)-B > (T-S), the deficits are sustainable.
If the formula goes the other way, then over time, the economy will be overwhelmed with debt.
If (R+I)-B < (T-S), the deficits are not sustainable.
It’s The PDS Trend That Matters Most
The PDS Framework lets you see whether things are good or bad but what matters most is whether the trend is getting better or worse.
This framework means that total debt can increase and the government can run a deficit provided the economic growth rate is high enough.
Flexibility In Macroeconomic Approaches
The formula points to different ways to improve the situation:
- Growth is the obvious answer but it’s easier said than done
- Mild inflation is also a help. This is why an inflation target of 2% is common for central banks.
- Shrinking the deficit either by tax increases or spending cuts. Both are difficult for politicians because it means that some people lose.
While these are independent in the formula, they are linked in real life which makes things more complicated. If inflation is high, there will be pressure to increase borrowing costs to maintain real interest rates. Deficit spending is supposed to support economics growth in the Keynesian economics framework and reducing spending or increasing taxes to trim the deficit will reduce growth. Interest rates will also increase if the deficit is large because the government must make its bonds attractive to investors.
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