“A Decade of Debt” by Reinhart and Rogoff: Trends toward “Financial Repression” of Economic Activity

15 05 2011

On March 28, 2011 macroeconomists Carmen Reinhart (bio) and Kenneth Rogoff (bio) recently made available a paper titled “A Decade of Debt” addressing the track record of the impact of major increases in public indebtedness upon various countries economic performance in recent history.  The paper is published as a discussion paper on VoxEU.org (http://globalcrisisdebate.info/), which is “a policy portal set up by the Centre for Economic Policy Research (www.CEPR.org) in conjunction with a consortium of national sites.”

“A Decade of Debt” provides a sobering and objective analysis of a) how public and private indebtedness has affected world economies in recent history (i.e., Japan, Iceland), and b) the impacts that current public indebtedness in the United States and elsewhere can be expected to have in the next decade.  Following is the web reference to obtain a free pdf of the paper (http://globalcrisisdebate.info/index.php?q=node/6295) as well as the paper’s abstract…..

Abstract of “A Decade of Debt” by Reinhart & Rogoff

This paper presents evidence that public debts in the advanced economies have surged in recent years to levels not recorded since the end of World War II, surpassing the heights reached during the First World War and the Great Depression. At the same time, private debt levels, particularly those of financial institutions and households, are in uncharted territory and are (in varying degrees) a contingent liability of the public sector in many countries. Historically, high leverage episodes have been associated with slower economic growth and a higher incidence of default or, more generally, restructuring of public and private debts. A more subtle form of debt restructuring in the guise of “financial repression” (which had its heyday during the tightly regulated Bretton Woods system) also importantly facilitated sharper and more rapid debt reduction than would have otherwise been the case from the late 1940s to the 1970s. It is conjectured here that the pressing needs of governments to reduce debt rollover risks and curb rising interest expenditures in light of the substantial debt overhang (combined with the widespread “official aversion” to explicit restructuring) are leading to a revival of financial repression–including more directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, and tighter regulation on cross-border capital movements.

A few of the key points from the paper:

1) “The combination of high and climbing public debts (a rising share of which is held by major central banks) and the protracted process of private deleveraging makes it likely that the ten years from 2008 to 2017 will be aptly described as a decade of debt.”

2) “Historically, high leverage episodes have been associated with slower economic growth.”

3) Surges in private debt lead to private defaults (which most often become manifest in the form of banking crises). Banking crises are associated with mounting public debt, which ultimately lead to a higher incidence of sovereign default or, more generally, restructuring of public and private debts. Specifically, banking crises and surges in public debt help to “predict” sovereign debt crises.

4) “It is conjectured here that the pressing needs of governments to reduce debt rollover risks and curb rising interest expenditures in light of the substantial debt overhang, combined with an aversion to more explicit restructuring, may lead to a revival of financial repression. This includes more directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, and tighter regulation on cross-border capital movements.”

There is much to think about and digest in regards to Reinhart and Rogoff’s work. In future posts I will review parts of their paper.  This paper can provide some sober-minded, fact based objectivity for serious citizens to think about concerning the debt issues now being wrestled with by the United States.

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