Must-Read: Ken Rogoff: Debt Overhangs

Must-Read: The very sharp Ken Rogoff calls for Europe to undertake The Acceptable Year of the Lord–cancel the debts, and redistribute the land:

Kenneth Rogoff: A New Deal for Debt Overhangs?: “The International Monetary Fund’s acknowledgement that Greece’s debt is unsustainable could prove to be a watershed moment…

…There have been basically three schools of thought…. The… troika… holds that the eurozone’s debt-distressed periphery… requires strong policy discipline to prevent a short-term liquidity crisis from morphing into a long-term insolvency problem… bridge loans… giving them time to fix their budget problems and undertake structural reforms…. A second school of thought also portrays the crisis as a pure liquidity problem, but views long-term insolvency as an outside risk…. 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…. Northern Europe could easily have solved the problem by co-signing periphery debt…. 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…. The eurozone suffered a crisis of competence, not a crisis of confidence…. In fact, piling loans atop already-high debt burdens in the eurozone’s periphery entailed a significant gamble, particularly as the crisis erupted….

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…. 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… reality…. 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….

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.

I must say I do not really see why Rogoff insists that there has to be a choice between position (2) which he scorns and position (3) which he embraces. When the world returns–if it ever does–to a regime in which the safe interest rate is greater than the growth rate of the economy, there may well have to be hard decisions made about the necessity for debt writedowns and financial repression to deal with genuine insolvency problems. But as long as the interest rate r is and is expected to be less than the growth rate g, there is no such necessity. Better (as the Syriza government of Greece found) to focus on flows and restoring full employment now than on writing down debt stocks that have little impact in the short run.

August 4, 2015

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