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).

Reinhart Reinhart

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

Reinhart

Output, Crises and Recovery Reinhart and Rogoff (2014) updated with World Economic Outlook, April 2016

Reinhart 5

% 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

Reinhart

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.

Reinhart 6

Reinhart

The incidence of deflation and high inflation,

22 advanced economies, 1945-2016

Reinhart 7

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

Reinhart Reinhart

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

Reinhart Reinhart

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

Reinhart Reinhart

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

Reinhart

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)

Reinhart

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)

Reinhart

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

Reinhart

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

Reinhart Reinhart

Real interest rates, financial

regulation, and the post crisis

re-emergence of

financial repression

18

Reinhart Reinhart

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.

Reinhart

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

Reinhart Reinhart Reinhart

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

Reinhart

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)

Reinhart

Reinhart Reinhart

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….

Reinhart

Like prior measures, this has increased the demand for

government paper. Other examples are numerous…

Reinhart

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.