American Economic Review: Papers & Proceedings 100 (May 2010): 573–578 http://www.aeaweb.org/articles.php?doi 10.1257/aer.100.2.573 = Growth in a Time of Debt By Carmen M. Reinhart and Kenneth S. Rogoff* In this paper, we exploit a new multi-country especially against the backdrop of graying pop- historical dataset on public government debt to ulations and rising social insurance costs? Are search for a systemic relationship( between) high sharply elevated public debts ultimately a man- public debt levels, growth and inflation.1 Our ageable policy challenge? main result is that whereas the link between Our approach here is decidedly empirical, growth and debt seems relatively weak at “nor- taking advantage of a broad new historical mal” debt levels, median growth rates for coun- dataset on public debt in particular, central tries with public debt over roughly 90 percent government debt first presented( in Carmen M. of GDP are about one percent lower than other- Reinhart and Kenneth) S. Rogoff 2008, 2009b . wise; average mean growth rates are several Prior to this dataset, it was exceedingly( difficult) percent lower.( Surprisingly,) the relationship to get more than two or three decades of pub- between public debt and growth is remarkably lic debt data even for many rich countries, and similar across emerging markets and advanced virtually impossible for most emerging markets. economies. This is not the case for inflation. We Our results incorporate data on 44 countries find no systematic relationship between high spanning about 200 years. Taken together, the debt levels and inflation for advanced econo- data incorporate over 3,700 annual observations mies as a group albeit with individual country covering a wide range of political systems, insti- exceptions including( the United States . By con- tutions, exchange rate and monetary arrange- trast, in emerging market countries, high) public ments, and historic circumstances. debt levels coincide with higher inflation. We also employ more recent data on external Our topic would seem to be a timely one. debt, including debt owed both by governments Public debt has been soaring in the wake of the and by private entities. For emerging markets, recent global financial maelstrom, especially in we find that there exists a significantly more the epicenter countries. This should not be sur- severe threshold for total gross external debt prising, given the experience of earlier severe public and private —which is almost exclu- financial crises.2 Outsized deficits and epic bank sively( denominated in) a foreign currency—than bailouts may be useful in fighting a downturn, for total public debt the domestically issued but what is the long-run macroeconomic impact, component of which (is largely denominated in home currency . When gross external debt reaches 60 percent) of GDP, annual growth * Reinhart: Department of Economics, 4115 Tydings Hall, University of Maryland, College Park, MD 20742 declines by about two percent; for levels of e-mail: [email protected] ; Rogoff: Economics Depart- external debt in excess of 90 percent of GDP, ment,( 216 Littauer Center, Harvard) University, Cambridge growth rates are roughly cut in half. We are not MA 02138–3001 e-mail: [email protected] . The ( ) in a position to calculate separate total exter- authors would like to thank Olivier Jeanne and Vincent R. nal debt thresholds as opposed to public debt Reinhart for helpful comments. ( 1 thresholds for advanced countries. The avail- In this paper “public debt” refers to gross central ) government debt. “Domestic public debt” is government able time-series is too recent, beginning only in debt issued under domestic legal jurisdiction. Public debt 2000. We do note, however, that external debt does not include debts carrying a government guarantee. levels in advanced countries now average nearly Total gross external debt includes the external debts of all branches of government as well as private debt that is issued 200 percent of GDP, with external debt levels by domestic private entities under a foreign jurisdiction. being particularly high across Europe. 2 Reinhart and Rogoff 2009a, b demonstrate that the ( ) The focus of this paper is on the longer term aftermath of a deep financial crisis typically involves a macroeconomic implications of much higher protracted period of macroeconomic adjustment, particu- larly in employment and housing prices. On average, public public and external debt. The final section, how- debt rose by more than 80 percent within three years after ever, summarizes the historical experience of a crisis. the United States in dealing with private sector 573 574 AEA PAPERS AND PROCEEDINGS MAY 2010 Debt GDP This general rise in public indebtedness stands in 2007 100 100 150 200 250 / = 2009 stark contrast to the 2003–2006 period of pub- Iceland 69 lic deleveraging in many countries and owes to Ireland 44 UK 72 direct bailout costs in some countries, the adop- Spain 42 tion of stimulus packages to deal with the global US 175.1 84 recession in many countries, and marked declines Crisis country average increase of 75% 62 ( ) Norway in government revenues that have hit advanced Australia 22 and emerging market economies alike. China 9 21 Thailand 29 Mexico II. Debt, Growth, and Inflation 25 Malaysia 47 Greece 119 The nonlinear effect of debt on growth is Canada 47 Austria reminiscent of “debt intolerance” Reinhart, 62 ( Chile Rogoff, and Miguel A. Savastano 2003 and 4 Germany ) 44 presumably is related to a nonlinear response Japan 182 Brazil of market interest rates as countries reach debt 46 Korea 32 tolerance limits. Sharply rising interest rates, India 41 in turn, force painful fiscal adjustment in the Average for others 120 increase of 20% ( ) 49 form of tax hikes and spending cuts, or, in some cases, outright default. As for inflation, Figure 1. Cumulative Increase in Real Public Debt an obvious connection stems from the fact that Since 2007, Selected Countries unanticipated high inflation can reduce the real cost of servicing the debt. Of course, the Note: Unless otherwise noted these figures are for central efficacy of the inflation channel is quite sen- government debt deflated by consumer prices. sitive to the maturity structure of the debt. In Sources: Prices and nominal GDP from International principle, the manner in which debt builds up Monetary Fund, World Economic Outlook. For a complete can be important. For example, war debts are listing of sources for government debt, see Reinhart and Rogoff 2009b . arguably less problematic for future growth ( ) and inflation than large debts that are accu- mulated in peacetime. Postwar growth tends to be high as wartime allocation of manpower deleveraging of debts, normal after a financial and resources funnels to the civilian economy. crisis. Not surprisingly, such episodes are asso- Moreover, high wartime government spending, ciated with very slow growth and deflation. typically the cause of the debt buildup, comes to a natural close as peace returns. In contrast, I. The 2007–2009 Global Buildup in Public Debt a peacetime debt explosion often reflects unsta- ble political economy dynamics that can persist Figure 1 illustrates the increase in inflation- for very long periods. adjusted public debt that has occurred( since Here we will not attempt to determine the gen- 2007. For) the five countries with systemic finan- esis of debt buildups but instead simply look at cial crises Iceland, Ireland, Spain, the United their connection to average and median growth Kingdom, and( the United States , average debt and inflation outcomes. This may lead us, if any- levels are up by about 75 percent, well) on track to thing, to understate the adverse growth implica- reach or surpass the three year 86 percent bench- tions of debt burdens arising out of the current mark that Reinhart and Rogoff 2009a,b , find crisis, which was clearly a peacetime event. for earlier deep postwar financial( crises. )Even in countries that did not experience a major finan- cial crisis, debt rose by an average of about 20 percent in real terms between 2007 and 2009.3 debt are not available for many countries. Of course, the true run-up in debt is significantly larger than stated here, at least on a present value actuarial basis, due to the exten- sive government guarantees that have been conferred on the 3 Our focus on gross central government debt owes to financial sector in the crisis countries and elsewhere, where the fact that time series of broader measures of government for example deposit guarantees were raised in 2008. VOL. 100 NO. 2 Growth in A Time Of Debt 575 5.0 6 above 90 percent very high . The bars in Figure GDP growth bars, left axis ( ) ( ) 2 show average and median GDP growth for 5.5 each of the four debt categories. Note that of the 4.0 1,186 annual observations, there are a significant number in each category, including 96 above 90 Inflation 5 line, right axis percent. Recent observations in that top bracket ( ) ( 3.0 come from Belgium, Greece, Italy, and Japan. 4.5 From the figure, it is evident that there is no) n obvious link between debt and growth until pub- o i GDP growth t a 2.0 4 l f lic debt reaches a threshold of 90 percent. The n I observations with debt to GDP over 90 percent 3.5 have median growth roughly 1 percent lower than 1.0 the lower debt burden groups and mean levels of growth almost 4 percent lower. Using lagged 3 debt does not dramatically change( the picture. ) 0.0 The line in Figure 2 plots the median inflation for Average Median Average Median Average Median Average Median 2.5 the different debt groupings—which makes plain Debt GDP Debt GDP Debt GDP Debt GDP / / / / below 30% 30 to 60% 60 to 90% above 90% that there is no apparent pattern of simultaneous 1.0 2 rising inflation and debt.