Saturday, March 12, 2011

Lifting the Crushing Burden of Debt

by Carmen M. Reinhart

Testimony before the hearing "Lifting the Crushing Burden of Debt" of the US House of Representatives Committee on the Budget
Peterson Institute for International Economics
March 10, 2011

Thank you, Chairman Ryan and the other members of the Committee, for the opportunity to comment on the US economy and the risks for the federal budget and debt. I am currently Dennis Weatherstone Senior Fellow at the Peterson Institute for International Economics. I suspect that I was invited to this hearing titled "Lifting the Crushing Burden of Debt" because, for more than a decade, my research has focused on various types of financial crises, including their fiscal implications and other economic consequences. Specifically, some of this work has focused on the historical and international evidence on the links between public debt and economic growth.

The march from financial crisis to high public indebtedness to sovereign default or restructuring is usually marked by episodes of drama, punctuated by periods of high volatility in financial markets, rising credit spreads, and rating downgrades. This historic pattern is unfolding in several European countries at present. That situation is far from resolved and remains a source of uncertainty for the United States and the rest of the world. However, the economic effects of high public indebtedness are not limited to turmoil in financial markets. Quite often, a build-up of public debt often does not trigger expectations of imminent sovereign default and the associated climb in funding costs. But in the background, a serious public debt overhang may cast a shadow on economic growth over the longer term, even when the sovereign’s solvency is not called into question.

In a paper written over a year ago with my coauthor Ken Rogoff from Harvard University, we examined the contemporaneous connection between debt and growth. I summarize here some of the main findings of that paper and as well as our recent related work and relevant studies from the International Monetary Fund (IMF) and European Central Bank (ECB).

Our analysis was based on newly-compiled data on 44 countries spanning about 200 years. This amounts to 3,700 annual observations and covers a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. The annual observations were grouped into four categories, according to the ratio of gross central government debt to GDP during that particular year: years when debt-to-GDP levels were below 30 percent; 30 to 60 percent; 60 to 90 percent; and above 90 percent. Recent observations in that top bracket come from Belgium, Greece, Italy, and Japan.

The main finding of that study is that the relationship between government debt and real GDP growth is weak for debt-to-GDP ratios below 90 percent of GDP. Above the threshold of 90 percent, however, median growth rates fall by 1 percent, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies to both the post World War II period and as far back as the data permit (often well into the 1800s).


Read the Paper

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