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Abstract
Even after one of the most severe multi-year crises on record in the advanced economies, the received wisdom in policy circles clings to the notion that high income countries are completely different from their emerging market counterparts. The current phase of the official policy approach is predicated on the assumption that debt sustainability can be achieved through a mix of austerity, forbearance and growth. The claim is that advanced countries do not need to resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression.
As the authors document, this claim is at odds with the historical track record of most advanced economies, where debt restructuring or conversions, financial repression and a tolerance for higher inflation, or a combination of these, were an integral part of the resolution of significant past debt overhangs.
Writing for the WSJ, Matthew Dalton comments:
The two economists... point out that European policymakers have been mostly ignoring the tools that have been used in the past to cut debt, of governments as well as the private sector. These tools include debt restructuring, inflation and “financial repression” — using government power to force the financial sector to cough up cheap financing. Instead, Europe’s strategy for cutting debt has focused on sharp deficit cuts and “structural reforms” that policymakers hope will generate economic growth.
Europe and other developing economies don’t want to go down the restructuring-inflation-repression route to debt reduction, the economists write, because that’s what basket-case, banana-republic economies do to deal with their debt problems. Except history says otherwise:
Although the view that advanced country financial crises are completely different, and therefore should be handled completely differently, has been a recurrent refrain, notably in both the European sovereign debt crises and the U.S. subprime mortgage crisis, this view is at odds with the historical track record. In most advanced economies, debt restructuring or conversions, financial repression, and higher inflation have been integral parts of the resolution of significant debt overhangs.
What does this mean for the eurozone? Policymakers here are still in the “denial cycle", R&R write. Eurozone debt restructuring will be needed, far beyond what’s now being discussed in public. And debt “mutualisation” — the northern, “core” countries of the eurozone taking on the debt burdens of the South — is probably not a good alternative, they write:
… the size of the overall problem is such that mutualisation could potentially result in continuing slow growth or even recession in the core countries, magnifying their own already challenging sustainability problems for debt and old-age benefit programmes.
Full article © WSJ