Debt Overhangs and Their

Resolution

Carmen M. Reinhart Harvard University

Bruegel Annual Meetings Brussels, September 6-7, 2016 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

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 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.

Reinhart 4 Output, Crises and Recovery Reinhart and Rogoff (2014) updated with World Economic Outlook, April 2016

% change Number of years 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. Reinhart 5  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 The incidence of deflation and high inflation, 22 advanced economies, 1945-2016

Share of advanced economies (22 countries) 100

90

80 Share with annual inflation above 10% 70

60

50 Share with deflation 40

30

20

Iceland 10 Japan 2008-2009

0 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Reinhart 7 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.

Reinhart 8 Gross Total (Public plus Private) External Debt as a Percent of GDP: 22 Advanced Economies, 300 1970-2016:Q1

250

200

% of GDP of % 150

100

50

0 197019721974197619781980198219841986198819901992199419961998200020022004200620082010201220142016

Reinhart 9

The contrast of the Asian Crisis: External Total (Public plus Private) External Debt in Six Asian Economies, 1970-2013 (percent of GDP) Percent 85

Average for India, Indonesia, Korea, Malaysia, Philippines, 75 and Thailand

65

55

45

35

25 Banking crises in at least three countries (shaded)

15 1970 1975 1980 1985 1990 1995 2000 2005 2010

Sources: International Monetary Fund, World EconomicReinhart Outlook, Reinhart and Rogoff (2009), Reinhart (2010), World Bank 10 (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

Undoing debt overhangs

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). Reinhart Preamble: Financial repression defined

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 Public debt as a percent of GDP: Advanced Economies: 1900-2016 S 100 WWII debts: Axis countries: default and WWI and Depression debts financial repression/inflation advanced and emerging Allies: financial 90 economies: default, repression/inflation restructuring and

80

70

60

50

40

30

20 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Reinhart 13 Public debt reduction has not always been orthodox --even in advanced economies Reinhart, Reinhart and Rogoff (2015) 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

Reinhart

Official debt is the Greek story (but is also substantive for Ireland and Portugal) Arslanalp and Tsuda, (2014) Greece

100% 200

90% 180

80% 160

70% 140

60% 120

50% 100 Percent of total of Percent

40% 80 GDP of Percent

30% 60

20% 40

10% 20

0% 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

100% Domestic central bank Domestic bank Domestic nonbank Foreign official sector100 1xxx. 0% 0

2004 2005 2006 2007 2008 2009 2010 2011 2012

of GDP of

of total of Percent Percent Foreign bank Foreign nonbank Total debt (rhs) Percent Reinhart Reinhart 15 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

1.30 Index T=1

1.20

GDP for 15 advanced economy interwar episodes (T=1934)

1.10

1.00 GDP for 30 middle-to-high income emerging market episodes, 1978-2010 (T=year of final restructuring)

0.90

0.80 T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5

Reinhart

Real interest rates, financial regulation, and the post crisis re-emergence of financial repression

Reinhart 18 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

(left scale, tan bars) (right scale, red bars) Share of Number of countries with countries with negative real rates negative real rates 100 16 Rates are on 3-month T-bills or 2-year bonds 90 advanced economies, 1945-2016 14

80 12 70

10 60

50 8

40 6

30 4 20

2 10

0 0 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Reinhart 20 Real T-bill Rates Frequency Distributions: 22 Advanced Economies, 1945-2015

Percent of 1946-1979 1980-2007 2008-2015 observations 35

Real Interest rate on T-bills 30 Share of obsevations at or below: 1945-1979 1980-2007 2008-2015 -1 percent -33.9 -5.7 -28.8 25 0 -47.8 -11.3 -57.7 1 percent -62.8 -23.1 -85.9 2 percent -76.5 -38.8 -95.5 20

15

10

5

0 -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) Reinhart 21 The incidence of negative real long-term interest rates in advanced economies, 1945-2016 (left scale, tan bars) (right scale, red bars) Share of Number of countries with countries with negative real rates negative real rates

100 20

90 18

80 16

70 14

60 12

50 10

40 8

30 6

20 4

10 2

0 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Reinhart 22 "World" Real Short-term Interest Rates, 1870-2016 (September 1)

Reinhart Selected post crisis regulatory changes with financial repression features

Reinhart 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 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.

Reinhart