The Euro crisis has re-entered a phase which makes turning on the news slightly nerve-wracking – and I’m not even a policy maker. So I turned off the radio and picked up once again that indispensable reference book, [amazon_link id=”0691152640″ target=”_blank” ]This Time Is Different[/amazon_link] by Carmen Reinhart and Kenneth Rogoff. Their argument of course is that every time during the past eight centuries an economy has been in a financial bubble, people have deluded themselves that it will all end well this time.
Looking at their conclusions on managing out of a debt crisis, however, it’s hard to escape the sinking feeling that the scale of the challenge this time around *is* absolutely unprecedented. They note:
1. It is vital to have a full picture of all government indebtedness, not just external, and include the contingent liabilities such as future pensions. (Has anybody done this for Spain or Italy with their rapidly ageing and shrinking populations?)
2. We must remember that very, very few economies grow their way out of a debt crisis, and the realisation that this hope is delusional often brings about a sudden halt to all capital inflows.
3. “Many governments have succumbed to the temptation to inflate away domestic debt.”
4. Banking crises are protracted.
I’m not a macroeconomist, and have been watching the tennis match between pro-stimulus and pro-austerity macro people with the same bemusement as the general population. So although I appreciate that very eminent economists insist there is no danger of inflation given the current weakness of growth, and that it is naive to say QE will result in inflation, I’m still going to turn my thoughts to index-linked and real assets when it comes to pension planning. I suspect I’ll be competing with all those Greeks, Italians, Spaniards and Portuguese looking to park their savings outside their own economies.
[amazon_image id=”0691152640″ link=”true” target=”_blank” size=”medium” ]This Time Is Different: Eight Centuries of Financial Folly[/amazon_image]
You always recommend excellent books: I bought this a few months ago but with preparing students for exams it’s proved a bit tough. So, can you explain 2, why is growing out of debt a delusion? That fits my instincts but seems hard to square with current situation.
The answer in the book is empirical: the length of downturn after a serious crisis has averaged 10 years in the past, and inflating away much of the burden has been the almost-universal exit route. The authors note that post-crisis fiscal stimulus packages typically have proven unsustainable because of the size of the government debt and debt-service requirements. My additional gloss is that the arithmetic of how much real growth is needed in Greece, Spain etc to reduce the debt burden, given the real interest rates they face, and the totality of implicit and explicit domestic and external debt, is implausibly high. They are countries with low average growth rates, structural impediments to growth, and disastrous demography.
I think the book bears chapters being skipped – you could pick out eg chapters 14, 17.
Thank you, much appreciated. Do you think then essentially most of the west simply has to wait for the economy to repair itself? It seems that curing a problem created by debt cannot realistically be cured with more: there does come a point when lenders stop lending. Austerity is very tough on some but perhaps instead of falsely promising growth and relief a fairer policy might simply be to redistribute incomes. I felt a but tax hit in my pay packet this month but least this seems to be paying for a tax cut for people on low incomes.
I find it hard to conclude anything other than that the (average) living standard of the early 2000s was unsustainable, and am not optimistic. But as I say, I’m not a macroeconomist and plenty of them do seem to think less austerity would make a big difference….
Diane – a good post
It would appear highly likely your view that “This time is worse” is agreed by Rogoff and Reinhardt. A new NBER paper by Rogoff and the two Reinhardts (husband and wife) (link = http://www.nber.org/papers/w18015 ) and summarised on Bloomberg here ( http://www.bloomberg.com/news/2012-04-30/reinharts-rogoff-see-huge-output-losses-from-high-debt.html ) argues
(a) the number of years of lower growth associated with correcting debt overhang averages about 23 years . From what I can understand from the summary of the NBER paper (not having read it) adjustments to previous estimates are made to take account of debt build ups immediately after World War I and II.
(b) From the Bloomberg article the authors say “The fact many countries are facing quadruple debt overhang problems – public, private, external and pension – suggests the problem could be worse than in the past”.
As to your comments about inflation, the near term outlook for inflation is probably benign due to excess capacity but the longer term outlook less so because higher inflation is often part of the way implicitly chosen to decrease debt . But concentrating on inflation alone is only part of the way chosen to reduce debt ratios. It is worth considering the wider concept of “financial repression” that Carmen Reinhardt has written extensively on. This covers issues such as fiscal drag and macro-prudential monitoring of financial institutions and pension funds making them into forced buyers of government debt.
I also suspect your comment that the standard of living in 2000 was unsustainable is correct for many advanced economies – but not necessarily so for many countries in Africa and Asia, where growth is and should remain many times higher than in “the West”.
Ian, thank you for these excellent points, and the links. I wholeheartedly agree with your last comment.