Aug 4th 2015

A New Deal for Debt Overhangs?

by Kenneth Rogoff

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.
CAMBRIDGE – The International Monetary Fund’s acknowledgement that Greece’s debt is unsustainable could prove to be a watershed moment for the global financial system. Clearly, heterodox policies to deal with high debt burdens need to be taken more seriously, even in some advanced countries.

Ever since the onset of the Greek crisis, there have been basically three schools of thought. First, there is the view of the so-called troika (the European Commission, the European Central Bank, and the IMF), which holds that the eurozone’s debt-distressed periphery (Greece, Ireland, Portugal, and Spain) requires strong policy discipline to prevent a short-term liquidity crisis from morphing into a long-term insolvency problem.

The orthodox policy prescription was to extend conventional bridge loans to these countries, thereby giving them time to fix their budget problems and undertake structural reforms aimed at enhancing their long-term growth potential. This approach has “worked” in Spain, Ireland, and Portugal, but at the cost of epic recessions. Moreover, there is a high risk of relapse in the event of a significant downturn in the global economy. The troika policy has, however, failed to stabilize, much less revive, Greece’s economy.

A second school of thought also portrays the crisis as a pure liquidity problem, but views long-term insolvency as an outside risk at worst. The problem is not that the debt of countries on the eurozone’s periphery is too high, but that it has not been allowed to rise nearly high enough.

This anti-austerity camp believes that even when private markets totally lost confidence in Europe’s periphery, northern Europe could easily have solved the problem by co-signing periphery debt, perhaps under the umbrella of Eurobonds backed ultimately by all (especially German) eurozone taxpayers. The periphery countries should then have been permitted not only to roll over their debt, but also to engage in full-on countercyclical fiscal policy for as long as their national governments deemed necessary.

In other words, for “anti-austerians,” the eurozone suffered a crisis of competence, not a crisis of confidence. Never mind that the eurozone has no centralized fiscal authority and only an incomplete banking union. Never mind moral-hazard problems or insolvency. And never mind growth-enhancing structural reforms. All of the debtors will be good for the money in the future, even if they have not always been reliable in the past. In any case, faster GDP growth will pay for everything, thanks to high fiscal multipliers. Europe passed up a free lunch.

This is a fully coherent viewpoint, but naive in its unqualified confidence (for example, in the polemical writings of the Nobel laureate economist Paul Krugman). As a result, the anti-austerian view masks strong assumptions and risks. In fact, piling loans atop already-high debt burdens in the eurozone’s periphery entailed a significant gamble, particularly as the crisis erupted.

Political corruption, exemplified by the revolving door between Spain’s government and financial sector, was endemic. Dual labor markets and product-market monopolies still hobble growth, and oligarchs have disproportionate power to protect their interests. In reality, Germany could not have underwritten all of the European periphery’s debt without risking its own solvency and creditworthiness, particularly in the absence of a functioning system of eurozone-wide checks and balances. Expansive and open-ended guarantees might have worked, but if they didn’t, the economic rot from the periphery could have spread to the center.

A third point of view is that, given the massive financial crisis, Europe’s debt problem should have been diagnosed as an insolvency problem from the start, and treated with debt restructuring and forgiveness, aided by moderately elevated inflation and structural reform. This has been my viewpoint since the crisis began.

In Ireland and Spain, private bondholders, not Irish and Spanish taxpayers, should have taken the hit from bank failures. In Greece, there should have been faster and larger debt write-downs.

Of course, national governments would have had to use taxpayer funds to recapitalize northern European banks – especially in France and Germany – that lent too much to the periphery. And transfers would have been needed to recapitalize the periphery banks. But at least then the public would have understood the reality of the situation, while restructured and recapitalized banks would have been in a position to start lending again.

Unfortunately, too many policymakers in advanced economies allowed themselves to believe that such heterodox policies are only for emerging markets. In fact, advanced countries have resorted to heterodox policies to reduce debt overhangs on many occasions. Debt restructuring would have given Europe the reset it needed. Yes, there would have been risks, as IMF chief economist Olivier Blanchard has pointed out, but running those risks would have been well worth it.

So what is the way forward? Deeper European integration, stricter equity requirements for banks, and deeper but homegrown structural reforms are certainly key elements of any solution. Further aid to the European periphery is still badly needed.

But, beyond that, Europe’s experience ought to spur a full rethink of the global system for administering sovereign bankruptcies. That could mean bringing back older IMF proposals for a sovereign bankruptcy mechanism, or finding ways to institutionalize the Fund’s recent stance on Greek debt. There is no free lunch in Europe, and there never was; but there are much better ways to deal with unsustainable debt.


Copyright: Project Syndicate, 2015.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Dec 5th 2019
EXTRACT: "Europe must fend for itself for the first time since the end of World War II. Yet after so many years of strategic dependence the US, Europe is unprepared – not just materially but psychologically – for today’s harsh geopolitical realities. Nowhere is this truer than in Germany."
Nov 23rd 2019
Extdact: "The kind of gratitude expressed by Vindman and my grandfather is not something that would naturally occur to a person who can take his or her nationality for granted, or whose nationality is beyond questioning by others. Some who have never felt the sharp end of discrimination might even find it mildly offensive. Why should anyone be grateful for belonging to a particular nation? Pride, perhaps, but gratitude? In fact, patriotism based on gratitude might be the strongest form there is."
Nov 20th 2019
Extract: "Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black."
Nov 17th 2019
Extract: "Digital money is already a key battleground in finance, with technology firms, payment processing companies, and banks all vying to become the gateway into the burgeoning platform-based economy. The prizes that await the winners could be huge. In China, Alipay and WeChat Pay already control more than 90% of all mobile payments. And in the last three years, the four largest listed payment firms – Visa, Mastercard, Amex, and PayPal – have increased in value by more than the FAANGs (Facebook, Apple, Amazon, Netflix, and Google)."
Nov 14th 2019
Extract: "Trump, who understands almost nothing about governing, made a major mistake in attacking career public officials from the outset of his presidency. He underestimated – or just couldn’t fathom – the honor of people who could earn more in the private sector but believe in public service. And he made matters worse for himself as well as for the government by creating a shadow group – headed by the strangely out-of-control Rudy Giuliani, once a much-admired mayor of New York City, and now a freelance troublemaker serving as Trump’s personal attorney – to impose the president’s Ukraine policy over that of “the bureaucrats.” "
Nov 4th 2019
Extract: "Trump displays repeated and persistent behaviours consistent with narcissistic personality disorder and antisocial personality disorder. These behaviours include craving for adulation, lack of empathy, aggression and vindictiveness towards opponents, addiction to lying, and blatant disregard for rules and conventions, among others." The concern is that leaders with these two disorders may be incapable of putting the interests of the country ahead of their own personal interests. Their compulsive lying may make rational action impossible and their impulsiveness may make them incapable of the forethought and planning necessary to lead the country. They lack empathy and are often motivated by rage and revenge, and could make quick decisions that could have profoundly dangerous consequences for democracy.
Oct 31st 2019
EXTRACT: "......let’s see what happens when we have less money for all the things we want to do as a country and as individuals. Promises and predictions regarding Brexit will soon be tested against reality. When they are, I wouldn’t want to be one of Johnson’s Brexiteers."
Oct 21st 2019
EXTRACT: "Were Israel to be attacked with the same precision and sophistication as the strike on Saudi Arabia, the Middle East would be plunged into war on a scale beyond anything it has experienced so far. Sadly (but happily for Russian President Vladimir Putin), that is the reality of a world in which the US has abandoned any pretense of global leadership."
Oct 20th 2019
EXTRACT: "Europe also stands to lose from Trump’s abandonment of the Kurds. If, in the ongoing chaos, the thousands of ISIS prisoners held by the Kurdish-led Syrian Democratic Forces escape – as some already have – America’s estranged European allies will suffer. Yet Trump is unconcerned. “Well, they are going to be escaping to Europe, that’s where they want to go,” he remarked casually at a press conference. “They want to go back to their homes." "
Oct 15th 2019
EXTRACT: "Assuming the House ultimately votes to impeach Trump, the fact remains that there are far fewer votes in the Senate than will be needed to convict him and remove him from office. But the willingness of Congress – including the Senate – to continue tolerating his dangerous conduct in office, including threats to US national security, is now truly in question."
Oct 7th 2019
EXTRACT: "The problem didn't start with the election of Donald Trump. Nor did it begin with the Democrats launching an impeachment inquiry against Trump. This is a developing crisis that has been growing like a cancer within our polity for at least the past 25 years. Its main symptoms are a lack of civility in our political discourse, a "take no prisoners" mindset, and a denial of the very legitimacy of "the other side." Trump didn't create this crisis; he was the result of it.   When Newt Gingrich took the helm of Congress in 1995, unlike previous Republican leaders, he embarked on a campaign not only to obstruct the efforts of then President Clinton, but to destroy him. Congress launched a series of investigations accusing Clinton of everything from corruption to obstruction of justice – with hints of even more nefarious plots to assassinate those who might pose a problem to his presidency.  "
Oct 4th 2019
EXTRACT: "As the story spreads, it grows darker. Meanwhile, Trump is trying to learn the identity of the whistleblower (who is protected by law), which could expose that person to great danger. And he is accusing some people – including Adam Schiff, the chair of the House Intelligence Committee – of treason. My sense is that Trump fears the tough, focused Schiff. Trump has ominously noted that traitors used to be shot or hanged. And he hasn’t helped himself with members of either party by declaring, in one of his hundreds of febrile tweets, that forcing him from office could lead to a “civil war.” Trump has taken the United States somewhere it’s never been before. His presidency may not survive it."
Sep 24th 2019
EXTRACT: "But regardless of whether the Ukraine scandal remains front-page news, it will haunt the US intelligence community, which has been Trump’s bête noire since the day he took office. Trump has relentlessly attacked US intelligence agencies, cozied up to Russian President Vladimir Putin, and divulged secrets to foreign officials, potentially burning high-value sources. This behavior had already raised serious concerns about whether Trump can be trusted to receive sensitive intelligence at all. Now, intelligence leaders must ask themselves how far they are willing to go in toeing the White House line."
Sep 21st 2019
EXTRACT: "As Lobaczewski pointed out, pathological leaders tend to attract other people with psychological disorders. At the same time, empathetic and fair-minded people gradually fall away. They are either ostracised or step aside voluntarily, appalled by the growing pathology around them.......As a result, over time pathocracies become more entrenched and extreme. You can see this process in the Nazi takeover of the German government in the 1930s, when Germany moved from democracy to pathocracy in less than two years.......In the US, there has clearly been a movement towards pathocracy under Trump. As Lobaczewski’s theory predicts, the old guard of more moderate White House officials – the “adults in the room” – has fallen away. The president is now surrounded by individuals who share his authoritarian tendencies and lack of empathy and morality. Fortunately, to some extent, the democratic institutions of the US have managed to provide some push back."
Sep 16th 2019
EXTRACT: "If the Supreme Court does agree with the Divisional Court that the question is political rather than legal, it will take the UK constitution into quite peculiar territory. Prime ministers will be the new kings and queens. They will be free to suspend parliament at will, and for as long as they wish, without any judicial interference. Parliament will meet not out of constitutional necessity but in the service of the government’s interests – namely, to pass its legislation and to maintain appearances, rather than to hold it to account."
Sep 12th 2019
Extract: "The Republican Party has lashed its fate to an increasingly unhinged leader. Though three other presidential hopefuls for 2020 now stand in Trump’s way, none can defeat him. But they can damage his reelection effort, which is why the Republican Party has been scrapping some primaries and caucuses. How well Trump does in November next year may well depend on how his fragile ego withstands the coming months."
Sep 2nd 2019
EXTRACTS: "Most people think of revolutions as sudden earthquakes or volcanic eruptions that come without warning and sweep away an entire political system. But historians, political scientists, and even the odd politician know that the reality is very different: revolutions happen when systems hollow themselves out, or simply rot from within. Revolutionaries can then brush aside established norms of behavior, or even of truth, as trivialities that should not impede the popular will............ Only time will tell whether we are currently witnessing the hollowing out of British democracy. But Prime Minister Boris Johnson may well have crossed some invisible Rubicon by.......... Whatever happens now, British parliamentary democracy may never be the same again. It will certainly never again be the model that so many people around the world once admired."
Aug 29th 2019
EXTRACT: "Events such as prorogations and dissolutions happen when countries face difficult times. Therefore, because of the disastrous effects of Brexit: sterling in freefall; a recession looming on the horizon and Britain’s international standing at its lowest ebb since Suez, it is no surprise that the country is in this position now. The worrying thing is that using the monarchical power of prorogation does not solve problems – it has a history of turning them into frightening and often violent crises. There is a worrying relationship between the use of such powers and a complete breakdown in government."
Aug 28th 2019
EXTRACT: "Reminiscent of Don Quixote, Trump is tilting at windmills. His administration is flailing at antiquated perceptions of the Old China that only compound the problems it claims to be addressing. Financial markets are starting to get a sense that something is awry. So, too, is the Federal Reserve. Meanwhile, the global economy is fraying at the edges. The US has never been an oasis in such treacherous periods. I doubt if this time is any different. 
Aug 24th 2019
EXTRACT: "In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession."