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36 Deleveraging, What Deleveraging
The other element of the denominator of the debt-capacity calculation is the
discount rate. Within the last 20 years, the premium on Italian over German debt
went from almost 5 percentage points to 20 basis points and nearly back again,
before falling to about 150 basis points. If the discount rate on future income
were to vary in that same range, the changes in the private sector’s assessment
of debt capacity would be sizable. Over the last 15 years, the accession of Italy to
the Eurozone compressed this spread, which, if extrapolated as a decline in the
discount rate, sharply raised debt capacity. What markets give they sometimes take
back, and the subsequent spread-widening resulted in a wrenching contraction
in the net present value of future output. The consequences for the ability to
manage debt in the transition are self-evident.