Carmen M. Reinhart
Harvard University
Bruegel Annual Meetings
Brussels, September 6-7, 2016
Debt Overhangs and Their
Resolution
Selected bibliography “Dealing with Debt,” (with Vincent Reinhart and Kenneth Rogoff), Journal of
International Economics, Vol. 86(1), April 2015, 543-555.
“Recovery from Financial Crises: Evidence from 100 Episodes,” (with Kenneth S.
Rogoff) American Economic Review, Vol. 104(5), May 2014, 50-55 (and update,
see https://www.project-syndicate.org/commentary/debt-restructuring-needed-as-
policy-option-by-carmen-reinhart-2016-04?barrier=true)
“The Liquidation of Government Debt,” (with M. Belen Sbrancia), NBER Working
Paper 16893, March 2011. Published in Economic Policy, Vol. 30(82), March 2015,
291-333.
“Sovereign Debt Relief and its Aftermath,” (with Christoph Trebesch). Journal of
the European Economic Association, Vol. 14(1), February 2016, 215-251.
“Public Debt Overhangs: Advanced-Economy Episodes since 1800” (with Vincent
R. Reinhart and Kenneth S. Rogoff) Journal of Economic Perspectives, Vol. 26(3),
Summer 2012, 69-86.
Reinhart
Reinhart
Outline of talk
Advanced economies post crisis
(i) Delayed recovery, (ii) deflationary
tendencies (iii) Debt overhangs
(ii) Undoing debt overhangs
Menu of options with a focus on:
(i) Debt restructuring, (ii) the role of monetary
policy and financial regulation (financial
repression).
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The 2007-2009 Crisis: Severity measures
It is still premature to construct a definitive
measure of the severity of the recent crises
Of the 11 advanced economies experiencing
a systemic crisis starting in 2007-2008
(France, Germany, Greece, Iceland,
Ireland, Italy, Netherlands, Portugal, Spain,
UK, and US), only Germany and the US
have reached their pre-crisis peak in per
capita GDP by 2014 and 2 more (Ireland
and UK) by 2015. 4
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Output, Crises and Recovery Reinhart and Rogoff (2014) updated with World Economic Outlook, April 2016
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% change
peak to peak to peak to Severity
trough trough recovery index
Year Country
2008 France -3.8 2 9 12.8
2008 Germany -5.3 1 3 8.3
2008 Greece -24.9 9 15 39.9
2007 Iceland -9.7 3 9 18.7
2007 Ireland -11.0 3 8 19.0
2008 Italy -10.9 7 15 25.9
2008 Netherlands -4.4 5 9 13.4
2008 Portugal -7.0 6 12 19.0
2008 Spain -10.3 6 11 21.3
2007 UK -5.9 2 8 13.9
2007 US -4.8 2 7 11.8
Summary Mean -8.9 4.2 9.6 18.5
Median -7.0 3.0 9.0 18.7
Note: The italics denote any calculation in which IMF estimates for 2014- are used.
Number of years
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The number of years to recover the pre-
crisis peak in per capita GDP in 100 of the
worst crises since the 1840s is about 8 years
(the median is 6 1/2 years).
In the 2007-2008 wave of crises, the average
may come in closer to 10 years.
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The incidence of deflation and high inflation,
22 advanced economies, 1945-2016
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Share of advanced
economies (22 countries)
0
10
20
30
40
50
60
70
80
90
100
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Share with annual inflationabove 10%
Share with deflation
Iceland
2008-2009Japan
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What factors have made this crisis so
protracted? What is the end-game?
The list includes:
the synchronous nature of the crisis,
the absence of greater exchange rate adjustment,
austerity,
the dearth of credit—(external or domestic),
the lack of deleveraging and write-downs (private or
public) almost a decade later.
8
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Gross Total (Public plus Private) External Debt as a
Percent of GDP: 22 Advanced Economies,
1970-2016:Q1
9 9
0
50
100
150
200
250
300
197019721974197619781980198219841986198819901992199419961998200020022004200620082010201220142016
% o
f G
DP
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The contrast of the Asian Crisis: External Total
(Public plus Private) External Debt in Six Asian
Economies, 1970-2013
(percent of GDP)
15
25
35
45
55
65
75
85
1970 1975 1980 1985 1990 1995 2000 2005 2010
Banking crises in at least three
countries (shaded)
Average for India, Indonesia,
Korea, Malaysia, Philippines,
and Thailand
Percent
Sources: International Monetary Fund, World Economic Outlook, Reinhart and Rogoff (2009), Reinhart (2010), World Bank
(2013), International Debt Statistics, Washington DC http://data.worldbank.org/data-catalog/international-debt-statistics,
and World Bank, Quarterly External Debt Statistics, (QEDS),
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/EXTDECQEDS/0,,menuPK:1805431~pagePK:64168
427~piPK:64168435~theSitePK:1805415,00.html
10
Undoing debt overhangs
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Throughout history, debt/GDP ratios have been
reduced by:
(i) economic growth;
(ii) fiscal adjustment/austerity;
(iii) explicit default or restructuring;
(iv) a sudden surprise burst in inflation; and
(v) a steady dosage of financial repression that is
accompanied by an equally steady dosage of
inflation.
(Options (iv) and (v) are only viable for domestic-
currency debts).
Preamble: Financial repression defined
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Financial repression involves a combination of tighter financial regulation and
(usually) sustained low or negative real interest rates. It is an opaque tax.
It can include directed lending to the government by:
Creating or broadening captive domestic audiences (such as pension funds or
domestic banks), explicit or implicit caps on interest rates, regulation of cross-border
capital movements, and (generally) a tighter connection between government and
banks, either explicitly through public ownership of some of the banks, balance sheet
exposure, or heavy “moral suasion”.
Financial repression is also sometimes associated with relatively high reserve
requirements (or liquidity requirements), securities transaction taxes, prohibition of
gold purchases (as in the US from 1933 to 1974), or the placement of significant
amounts of government debt that is nonmarketable.
In the current policy discussion, financial repression issues usually come under
the broad umbrella of “macro prudential regulation.”
Reinhart 13 Reinhart Reinhart
Public debt as a percent of GDP:
Advanced Economies: 1900-2016
20
30
40
50
60
70
80
90
100
1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011
WWI and Depression debts advanced and emerging
economies: default, restructuring and
WWII debts: Axis countries: default and
financial repression/inflation Allies: financial
repression/inflation
S
Public debt reduction has not always been orthodox
--even in advanced economies Reinhart, Reinhart and Rogoff (2015)
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Factors Behind Debt Reversals:
Fiscal Adjustment, Restructuring, Inflation, Growth, and Real Interest Rates
Growth Primary Real Inflation Default or
balance rates restructure
> median > median < median > median
Total sample, 70 episodes
Number of episodes 38 41 41 41 16
Share 0.54 0.61 0.59 0.59 0.23
Post-war cases, 36 episodes
Number of episodes 21 16 30 30 9
Share 0.58 0.48 0.86 0.83 0.25
Peacetime, 34 episodes
Number of episodes 17 25 11 11 7
Share 0.50 0.74 0.32 0.32 0.21
Memorandum items:
Share of debt reduction episodes associated with deflation
Total 0.07
War 0.11
Peace 0.03
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Official debt is the Greek story (but is also substantive for Ireland and Portugal)
Arslanalp and Tsuda, (2014)
0
20
40
60
80
100
120
140
160
180
200
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Perc
ent of G
DP
Perc
ent of to
tal
Greece
1xxx.
0100
0%100%
2004 2005 2006 2007 2008 2009 2010 2011 2012
Perc
ent
of
GD
P
Perc
ent
of
tota
l Domestic central bank Domestic bank Domestic nonbank Foreign official sector
Foreign bank Foreign nonbank Total debt (rhs)
15 Reinhart
Stylized crisis timeline of the 1920s/1930s and
1980s/1990s—it took a decade or more to arrive at
conclusive restructuring Reinhart and Trebesch (2016)
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Real Per Capita GDP Around Debt Relief Events (Exit from
Default) in Middle-High Income Emerging Markets (1978-2010) and
Advanced Economies (1934) 10-year window around debt relief event, level of real per capita GDP at T=1
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0.80
0.90
1.00
1.10
1.20
1.30
T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5
GDP for 15 advanced economy interwar episodes (T=1934)
GDP for 30 middle-to-high income emerging market episodes, 1978-2010 (T=year of final restructuring)
Index T=1
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Real interest rates, financial
regulation, and the post crisis
re-emergence of
financial repression
18
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Historical antecedents on financial repression (Reinhart and Sbrancia, 2011, 2015)
For the advanced economies, real interest
rates were negative roughly ½ of the time
during 1945-1980.
“Financial repression” was most successful
in liquidating debts when accompanied by a
steady dose of inflation.
Average annual interest expense savings as
a percent of GDP (FR tax) ranged from
about 1 to 5 percent of GDP for the full
1945-1980 sample.
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The incidence of negative real short-term interest
rates in advanced economies, 1945-2016
Reinhart 20
(left scale, tan bars) (right scale, red bars)
Share of Number of
countries with countries with
negative real rates negative real rates
0
2
4
6
8
10
12
14
16
0
10
20
30
40
50
60
70
80
90
100
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Rates are on 3-month T-bills or 2-year bondsadvanced economies, 1945-2016
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Real T-bill Rates Frequency Distributions:
22 Advanced Economies, 1945-2015
1945-1979 1980-2007 2008-2015
-1 percent -33.9 -5.7 -28.8
0 -47.8 -11.3 -57.7
1 percent -62.8 -23.1 -85.9
2 percent -76.5 -38.8 -95.5
Real Interest rate on T-bills
Share of obsevations at or below:
0
5
10
15
20
25
30
35
-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10
real interest rate on 3-month T-bills (percent)
1946-1979 1980-2007 2008-2015Percent of
observations
21
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The incidence of negative real long-term interest
rates in advanced economies, 1945-2016
Reinhart 22
(left scale, tan bars) (right scale, red bars)
Share of Number of
countries with countries with
negative real rates negative real rates
0
2
4
6
8
10
12
14
16
18
20
0
10
20
30
40
50
60
70
80
90
100
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
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"World" Real Short-term Interest Rates,
1870-2016 (September 1)
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Selected post crisis
regulatory changes with
financial repression
features
24
A very recent US example going into
effect in mid-October 2016
SEC Adopts Money Market Fund Reform Rules
https://www.sec.gov/News/PressRelease/Detail/PressRelease/137054234
7679
The new rules require a floating net asset value (NAV) for institutional
prime money market funds, which allows the daily share prices of
these funds to fluctuate along with changes in the market-based value
of fund assets and provide non-government money market fund
boards new tools – liquidity fees and redemption gates – to address
runs….
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Like prior measures, this has increased the demand for
government paper. Other examples are numerous…
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Reinhart Reinhart Reinhart
What is the end game for the advanced economies?
Now in 8th year post crisis, there are signs of
stabilization and recovery in much of Europe--yet per
capita output remains well below its pre-crisis peak in
many of the crisis countries (notably Greece and Italy).
Public debt overhangs usually last more than two
decades. (Reinhart, Reinhart and Rogoff, 2012). The
combination of sluggish growth and deflation or low
inflation does not contribute to their resolution.
Low and (negative) real interest rates may be necessary
to unwind public and private debt loads.
Write-downs of private debt and some sovereign official
debts seems probable.