2012 PublicDebtOverhangsAdvancedEcon
- (Reinhart et al., 2012) ⇒ Carmen M Reinhart, Vincent R Reinhart, and Kenneth S Rogoff. (2012). “Public Debt Overhangs: Advanced-economy Episodes Since 1800." JSTOR. doi:10.1257/jep.26.3.69
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Abstract
We identify the major public debt overhang episodes in the advanced economies since the early 1800s, characterized by public debt to GDP levels exceeding 90 percent for at least five years. Consistent with Reinhart and Rogoff (2010) and most of the more recent research, we find that public debt overhang episodes are associated with lower growth than during other periods. The duration of the average debt overhang episode is perhaps its most striking feature. Among the 26 episodes we identify, 20 lasted more than a decade. The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that the cumulative shortfall in output from debt overhang is potentially massive. These growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates, as in eleven of the episodes, interest rates are not materially higher.
1. Introduction
The recent financial crisis and recession has left a legacy of historically high and rising level of public indebtedness across the advanced economies. The central policy debate across Europe, Japan, and the United States now centers on how fast to stabilize soaring public debt/GDP ratios, given that post-crisis growth remains fragile. We bring evidence to bear on the issue by identifying the major public debt overhang episodes in advanced economies since the early 1800s. Following Reinhart and Rogoff (2010), we select stretches where gross public debt exceeds 90 percent of nominal GDP on a sustained basis. Such public debt overhang episodes are associated with lower growth than during other periods. Even more striking, among the 26 episodes we identify, 20 lasted more than a decade. The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that the cumulative shortfall in output from debt overhang is potentially massive. These growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates, in that in eleven of the episodes, interest rates are not materially higher.
In this paper, we use the long-dated cross-country data on public debt developed by Reinhart and Rogoff (2009) to examine the growth and interest rates associated with prolonged periods of exceptionally high public debt, defined as episodes where public debt to GDP exceeded 90 percent for at least five years. (The basic results here are reasonably robust to choices other than 90 percent as the critical threshold, as in Reinhart and Rogoff 2010a, b).1 Over the years 1800 –2011, we find 26 such episodes across the advanced economies. Previous studies of high public debt episodes have typically focused on the very small number of cases, including mainly the post-1970 or post-1980 cases. While data limitations may have prevented us from including every episode of high public debt in advanced economies since 1800, we are confident that this list encompasses the preponderance of such episodes. To focus on the association between high debt and long-term growth, we only cursorily treat shorter episodes lasting under five years, of which there turn out to be only a few. The long length of typical public debt overhang episodes suggests that even if such episodes are originally caused by a traumatic event such as a war or financial crisis, they can take on a self-propelling character.
Consistent with a small but growing body of research, we find that the vast majority of high debt episodes — 23 of the 26 — coincide with substantially slower growth. On average across individual countries, debt/GDP levels above 90 percent are associated with an average annual growth rate 1.2 percent lower than in periods with debt below 90 percent debt; the average annual levels are 2.3 percent during the periods of exceptionally high debt versus 3.5 percent otherwise. Of course, public debt overhang and slow growth are surely a simultaneous relationship: countries experiencing a period of slower growth may be more vulnerable to ending up with very high levels of public debt, and once the public debt overhang arises, countries with slower growth are going to take longer to escape it. As we shall discuss, a number of recent studies have concluded that the relationship cannot be entirely from low growth to high debt, and that very high debt likely does weigh on growth. Those who view the correlation from high debt to slower growth as mainly due to the cyclical effects of slowdowns on public finances will need to address certain aspects of the data. For example, why does the typical episode of high public debt last far beyond any plausible business cycle frequency — decades, not years? Also, if the debt-to-growth correlation is driven by business cycles, then why so little correlation between debt and growth below the 90 percent debt/GDP threshold, yet such a pronounced correlation above it?
Another contribution of this paper is to provide, to our knowledge, the first systematic evidence on the association between public debt overhang and real interest rates. The modern policy debate often presumes that the main cost of high public debt ultimately comes from sovereign default, with all its attendant disruptions and dislocations. However, we find that countries with a public debt overhang by no means always experience either a sharp rise in real interest rates or difficulties in gaining access to capital markets. Indeed, in 11 of the 26 cases where public debt was above the 90 percent debt/GDP threshold, real interest rates were either lower, or about the same, as during the lower debt/GDP years. This result is, for instance, consistent with the classic friction identified in Barro (1979) who, using a model where the government always pays in full, showed how ultimate debt stabilization requires raising distorting taxes or (in principle) adjusting expenditures, both of which potentially affect output.
We begin with a brief tour of the concept of debt overhangs in the advanced economies, including both public and private debt, both in historical context and relative to developments in emerging market economies. We then look more closely at the 26 debt overhang episodes we identify. In the background of this discussion, of course, lurks the rapid growth in public debt that many advanced economies have experienced in the last few years in the aftermath of financial crisis and recession. The high level of public debt in Greece has already sparked a broader crisis in the European Union, with the public debt/GDP ratios of several other European economies also a cause for concern, especially when the imputed costs of future bank bailouts are taken into account. The U.S. government surpassed a 90 percent ratio of gross federal debt/GDP in 2010, with Japan at debt/GDP levels more than twice as high.
Our work suggests that the long-term secular costs of high debt need to be weighed against the short-term expediency of Keynesian fiscal stimulus. Our work also highlights the historical importance of default, debt restructuring, and a variety of debt conversions (encompassing both voluntary and involuntary episodes) in coping with debt overhangs. “Credit events” are not just an emerging market phenomenon; these were commonplace among the advanced economies prior to World War II.
References
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| Author | volume | Date Value | title | type | journal | titleUrl | doi | note | year | |
|---|---|---|---|---|---|---|---|---|---|---|
| 2012 PublicDebtOverhangsAdvancedEcon | Vincent R Reinhart Carmen M. Reinhart Kenneth S. Rogoff | Public Debt Overhangs: Advanced-economy Episodes Since 1800 | 10.1257/jep.26.3.69 | 2012 |