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The Liquidation of Government Debt

Carmen Reinhart () and M. Belen Sbrancia ()
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M. Belen Sbrancia: University of Maryland

No WP11-10, Working Paper Series from Peterson Institute for International Economics

Abstract: Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of "financial repression." Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In this paper, the authors describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historical standards). For the advanced economies in Reinhart and Sbrancia's sample, real interest rates were negative roughly half of the time during 1945–80. For the United States and the United Kingdom, their estimates of the annual liquidation of debt via negative real interest rates amounted on average to 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum).

Keywords: Public Debt; Financial Repression; Inflation; Interest Rates; Debt Liquidation; Default; Restructuring; Debt Reduction (search for similar items in EconPapers)
JEL-codes: E2 E3 E6 F3 F4 H6 N10 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2011-04
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Related works:
Journal Article: The liquidation of government debt (2015) Downloads
Working Paper: The Liquidation of Government Debt (2015) Downloads
Working Paper: The Liquidation of Government Debt (2011) Downloads
Working Paper: The Liquidation of Government Debt (2011) Downloads
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