REINHART AND ROGOFF: Extreme Debt Means 1930s-Style Defaults May Be Coming To Much Of The Western World (2024)
Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund.
The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups.
Wikimedia Commons Debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, warns IMF paper.
“The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.
The paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”).
The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”.
But the paper says this mantra borders on “collective amnesia” of European and U.S. history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end. It is causing the crisis to drag on, blocking a lasting solution. “This denial has led to policies that in some cases risk exacerbating the final costs,” it said.
While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation.
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The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression — defined as an “opaque tax on savers” — as used in countless IMF rescues for emerging markets.
“The magnitude of the overall debt problem facing advanced economies today is difficult to overstate. The current central government debt in advanced economies is approaching a two-century high-water mark,” they said.
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Most advanced states wrote off debt in the 1930s, though in different ways. First World War loans from the U.S. were forgiven when the Hoover Moratorium expired in 1934, giving debt relief worth 24pc of GDP to France, 22pc to Britain and 19pc to Italy.
This occurred as part of a bigger shake-up following the collapse of the war reparations regime on Germany under the Versailles Treaty. The U.S. itself imposed haircuts on its own creditors worth 16pc of GDP in April 1933 when it abandoned the Gold Standard.
Financial repression can take many forms, including capital controls, interest rate caps or the force-feeding of government debt to captive pension funds and insurance companies. Some of these methods are already in use but not yet on the scale seen in the late 1940s and early 1950s as countries resorted to every trick to tackle their war debts.
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The policy is essentially a confiscation of savings, partly achieved by pushing up inflation while rigging the system to stop markets taking evasive action. The UK and the U.S. ran negative real interest rates of -2pc to -4pc for several years after the Second World War. Real rates in Italy and Australia were -5pc.
Both authors of the paper have worked for the IMF, Prof Rogoff as chief economist. They became famous for their best-selling work on sovereign debt crises over the ages, "This Time is Different: Eight Centuries of Financial Folly."
They were later embroiled in controversy over a paper suggesting that growth slows sharply once public debt exceeds 90pc of GDP. Critics say it is unclear whether the higher debt is the problem or whether the causality is the other way around, with slow growth causing the debt ratio to rise to faster.
The issue became highly politicised when German finance minister Wolfgang Schauble and EU economics commissioner Olli Rehn began citing the paper to justify eurozone austerity policies, over-stepping its more careful claims.
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Critics says extreme austerity without offsetting monetary stimulus is the chief reason why debts have been spiralling upwards even faster in parts of Southern Europe.
The weaker eurozone states are particularly vulnerable to default because they no longer have their own sovereign currencies, putting them in the same position as emerging countries that borrowed in dollars in the 1980s and 1990s. Even so, nations have defaulted through history even when they do borrow in their own currency.
Reinhart and Rogoff (2009, 2011) argue that total external debt is an important indicator because the boundaries between public and private debt can become blurred in a crisis.
But no, he was correct - he'd spotted a basic error in the spreadsheet. The Harvard professors had accidentally only included 15 of the 20 countries under analysis in their key calculation (of average GDP growth in countries with high public debt). Australia, Austria, Belgium, Canada and Denmark were missing.
The Reinhart-Rogoff research is best known for its result that, across a broad range of countries and historical periods, economic growth declines dramatically when a country's level of public debt exceeds 90% of gross domestic product.
The paper focuses on the main theoretical and empirical explanations of four types of financial crises—currency crises, sudden stops, debt crises, and banking crises—and presents a survey of the literature that attempts to identify these episodes.
Economics professor L. Randall Wray criticized Reinhart and Rogoff for combining data "across centuries, exchange rate regimes, public and private debt, and debt denominated in foreign currency as well as domestic currency," in addition to "statistical errors," and for lacking a "theory of sovereign currency".
The collapse of Lehman Brothers is often cited as both the culmination of the subprime mortgage crisis, and the catalyst for the Great Recession in the United States.
Rogoff is an elected member of the National Academy of Sciences and the American Academy of Arts and Sciences. He has long ranked among the top dozen most cited economists, and is an international grandmaster of chess.
Common Excel errors include #DIV/0!, #N/A, #NAME?, #NULL!, #NUM!, #REF!, and #VALUE! To fix these errors, we can adjust the column width, use IFERROR, check for formatting or syntax mistakes, or use formula auditing tools like Evaluate Formula and Error Checking.
Influential papers such as Reinhart and Rogoff (2010) and Reinhart, Reinhart, and Rogoff (2012) argue that there is a threshold effect: when debt in advanced economies exceeds 90 percent of GDP there is an associated dramatic worsening of growth outcomes.
Rogoff and other cognitive scientists follow Vygotskij in positing that individual cognitive skills derive from people's engagement in sociocultural activities. Rather than representing a general ability, cognition appears to be 'situated' in specific contexts, and learned through specific cultural activities.
Barbara Rogoff argues, however, that human development must be understood as a cultural process, not simply a biological or psychological one. Individuals develop as members of a community, and their development can only be fully understood by examining the practices and circ*mstances of their communities.
Key takeaways. When a bank fails, the FDIC or a state regulatory agency takes over and either sells or dissolves the bank. Most banks in the US are insured by the FDIC, which provides coverage up to $250,000 per depositor, per FDIC bank, per ownership category.
One of the International Monetary Fund's top economists signals little risk of a global recession, despite the ongoing rumblings of geopolitical uncertainty. The Washington DC-based institute this week nudged its global growth outlook slightly higher to 3.2% in 2024 and projects the same rate in 2025.
Encyclopædia Britannica, Inc. This was the worst financial and economic disaster of the 20th century. Many believe that the Great Depression was triggered by the Wall Street crash of 1929 and later exacerbated by the poor policy decisions of the U.S. government.
A (systemic) banking crisis occurs when many banks in a country are in serious solvency or liquidity problems at the same time—either because there are all hit by the same outside shock or because failure in one bank or a group of banks spreads to other banks in the system.
A recent Social Science Research Network study suggests that 186 American banks could fail if half of their depositors suddenly withdrew their funds. The researchers formulated a speculative scenario in which each bank experienced a run, and concluded that the FDIC would run out of money.
With lower monetary reserves in their vaults, major banks and financial institutions on the East Coast had to scale back their loans, which was a major cause of the panic, besides the real estate crash. Americans attributed the cause of the panic principally to domestic political conflicts.
Central Issue. From 1929-1933, thousands of banks in towns and cities across the nation failed and millions of Americans lost their life savings. The Glass-Steagall Banking Act stabilized the banks, reducing bank failures from over 4,000 in 1933 to 61 in 1934.
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But the paper says this mantra borders on “collective amnesia” of European and U.S. history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end. It is causing the crisis to drag on, blocking a lasting solution. “This denial has led to policies that in some cases risk exacerbating the final costs,” it said.
This occurred as part of a bigger shake-up following the collapse of the war reparations regime on Germany under the Versailles Treaty. The U.S. itself imposed haircuts on its own creditors worth 16pc of GDP in April 1933 when it abandoned the Gold Standard.
