Even after one of the most severe multi-year crisis on record in the advanced economies, the received wisdom in policy circles clings to the notion that high-income countries are completely different from their emerging market counterparts. The current phase of the official policy approach is predicated on the assumption that debt sustainability can be achieved through a mix of austerity, forbearance and growth. The claim is that advanced countries do not need to resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression. As we document, this claim is at odds with the historical track record of most advanced economies, where debt restructuring or conversions, financial repression, and a tolerance for higher inflation or a combination of these were an integral part of the resolution of significant past debt overhangs.
This paper offers a “panoramic” analysis of the history of financial crises dating from England’s fourteenth-century default to the current United States sub-prime financial crisis. Our study is based on a new dataset that spans all regions. It incorporates a number of important credit episodes seldom covered in the literature, including for example, defaults and restructurings in India and China. As the first paper employing this data, our aim is to illustrate some of the broad insights that can be gleaned from such a sweeping historical database. We find that serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies. Major default episodes are typically spaced some years (or decades) apart, creating an illusion that “this time is different” among policymakers and investors. A recent example of the “this time is different” syndrome is the false belief that domestic debt is a novel feature of the modern financial landscape. We also confirm that crises frequently emanate from the financial centers with transmission through interest rate shocks and commodity price collapses. Thus, the recent US sub-prime financial crisis is hardly unique. Our data also documents other crises that often accompany default: including inflation, exchange rate crashes, banking crises, and currency debasements.
The historical frequency of banking crises is similar in advanced and developing countries, with quantitative parallels in both the run-ups and the aftermath. We establish these regularities using a dataset spanning from the early 1800s to the present. Banking crises weaken fiscal positions, with government revenues invariably contracting. Three years after a crisis, central government debt increases by about 86%. The fiscal burden of banking crisis extends beyond the cost of the bailouts. We find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows and credit booms, in rich and poor countries alike.
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.
This paper uses a data set of over two hundred years of sovereign debt, banking and inflation crises to explore the question of how long it takes a country to “graduate” from the typical pattern of serial crisis that most emerging markets experience. We find that for default and inflation crises, twenty years is a significant market, but the distribution of recidivism has extremely fat tails. In the case of banking crises, it is unclear whether countries ever graduate. We also examine the more recent phenomenon of IMF programs, which sometimes result in “near misses” but sometimes end in default even after a program is instituted. The paper raises the important theoretical question of why countries experience serial default, and how they might graduate.
There is a rich scholarly literature on sovereign default on external debt. Comparatively little is known about sovereign default on domestic debt. Even today, cross-country data on domestic public debt remains curiously exotic, particularly prior to the 1980s. We have filled this gap in the literature by compiling a database on central government public debt (external and domestic). The data span 1914 to 2007 for most countries, reaching back into the nineteenth century for many. Our findings on debt sustainability, sovereign defaults, the temptation to inflate, and the hierarchy of creditors only scratch the surface of what the domestic public debt data can reveal. First, domestic debt is big—for the 64 countries for which we have long time series, domestic debt accounts for almost two-thirds of total public debt. For most of the sample, this debt carries a market interest rate (except for the financial repression era between WWII and financial liberalization). Second, the data go a long way toward explaining the puzzle of why countries so often default on their external debts at seemingly low debt thresholds. Third, domestic debt has largely been ignored in the vast empirical work on inflation. In fact, domestic debt (a significant portion of which is long term and non-indexed) is often much larger than the monetary base in the run-up to high-inflation episodes. Last, the widely held view that domestic residents are strictly junior to external creditors does not find broad support.
Newly developed long historical time series on public debt, along with modern data on external debts, allow a deeper analysis of the cycles underlying serial debt and banking crises. The evidence confirms a strong link between banking crises and sovereign default across the economic history of a great many countries, advanced and emerging alike. The focus of the analysis is on three related hypotheses tested with both “world” aggregate levels and on an individual country basis. First, private debt surges are a recurring antecedent to banking crises; governments quite often contribute to this stage of the borrowing boom. Second, banking crises (both domestic ones and those emanating from international financial centers) often precede or accompany sovereign debt crises. Indeed, we find they help predict them. Third, public borrowing accelerates markedly ahead of a sovereign debt crisis; governments often have “hidden debts” that far exceed the better documented levels of external debt. These hidden debts encompass domestic public debts (which prior to our data were largely undocumented).
We study economic growth and inflation at different levels of government and external debt. Our analysis is based on new data on forty-four countries spanning about two hundred years. The dataset incorporates over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. Our main findings are: First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies. Second, emerging markets face lower thresholds for external debt (public and private)—which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half. Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the United States, have experienced higher inflation when debt/GDP is high). The story is entirely different for emerging markets, where inflation rises sharply as debt increases.
This paper examines the depth and duration of the slump that invariably follows severe financial crises, which tend to be protracted affairs. We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Not surprisingly, banking crises are associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 percent, although the duration of the downturn is considerably shorter than for unemployment. The real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes. The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis. Our estimates of the rise in government debt are likely to be conservative, as these do not include increases in government guarantees, which also expand briskly during these episodes.
Is the 2007-2008 U.S. sub-prime mortgage financial crisis truly a new and different phenomena? Our examination of the longer historical record finds stunning qualitative and quantitative parallels to 18 earlier post-war banking crises in industrialized countries. Specifically, the run-up in U.S. equity and housing prices (which, for countries experiencing large capital inflows, stands out as the best leading indicator in the financial crisis literature) closely tracks the average of the earlier crises. Another important parallel is the inverted v-shape curve for output growth the U.S. experienced as its economy slowed in the eve of the crisis. Among other indicators, the run-up in U.S. public debt and is actually somewhat below the average of other episodes, and its pre-crisis inflation level is also lower. On the other hand, the United States current account deficit trajectory is worse than average. A critical question is whether the U.S. crisis will prove similar to the most severe industrialized-country crises, in which case growth may fall significantly below trend for an extended period. Or will it prove like one of the milder episodes, where the recovery is relatively fast? Much will depend on how large the shock to the financial system proves to be and, to a lesser extent, on the efficacy of the subsequent policy response.
Reinhart, Carmen M, Kenneth Rogoff, and Miguel A Savastano. 2003. “Debt Intolerance.” Brookings Papers on Economic Activity 1: 1–74. Abstract
This paper introduces the concept of debt intolerance,' which manifests itself in the extreme duress many emerging markets experience at debt levels that would seem manageable by advanced country standards. We argue that safe' external debt-to-GNP thresholds for debt intolerant countries are low, perhaps as low as 15 percent in some cases. These thresholds depend on a country's default and inflation history. Debt intolerance is linked to the phenomenon of serial default that has plagued many countries over the past two centuries. Understanding and measuring debt intolerance is fundamental to assess the problems of debt sustainability, debt restructuring, capital market integration, and the scope for international lending to ameliorate crises. Our goal is to make a first pass at quantifying debt intolerance, including delineating debtors' clubs and regions of vulnerability, on the basis on a history of credit events going back to the 1820s for over 100 countries.
This paper describes the evolution of ideas to apply bankruptcy reorganization principles to sovereign debt crises. Our focus is on policy proposals between the late 1970s and Anne Krueger's (2001) proposed 'Sovereign Debt Restructuring Mechanism," with brief reference to the economics literature on sovereign debt. We describe the perceived inefficiencies that motivate proposals, and how proposals seek to change debtor and creditor incentives. We find that there has been a moving consensus on what constitutes the underlying problem, but not on how to fix it. The range of proposed approaches remains broad and only recently shows some signs of narrowing.