Tag Archives: debt

Why the Government’s Student Debt Portfolio Isn’t as Bad as it Seems

Thesis: Fear that the federal government’s student debt holdings have become too large is overstated – partially because the increase in holdings fall in line with expectations, and partially because the default rate is inflated by declining for-profit college students.  

The federal government’s current student loan holdings are the highest they have ever been, sitting at about $876.1 billion.  As this graph of Fed data, published by QZ, demonstrates, the value of student burdens held by our government been steadily rising for the past two decades or so, with a shocking spike occurring right as the recession hit and no deceleration in sight.  The slow rise can be attributed to more and more Americans deciding to attend college over the past few decades, and the sharp rise can be attributed to two factors: students fretting about the job market and returning to school, and a reform of federal subsidies for student loans, which made the federal government the sole lender to students.  While we are likely seeing a permanent increase in loans, it is less shocking once one considers the circumstances – of course the federal loan holdings had to increase as the government captured the entire share of the student lending market.  And unlike the increased holdings, the increased rate of loan accumulation is not permanent – it will almost certainly begin to level off as the economy continues to grow and the job market improves, giving young Americans less desire to reach for higher levels of education.

federal-student-loans-outstanding-data_chartbuilder1

In its current state, the government’s loan portfolio provides a positive revenue flow, since the government borrows money at a much cheaper rate than students pay.  Despite this, some are worried about the size of that portfolio, as evidenced by a Bloomberg article which called it an “$800 billion gamble.”  Critics quoted in the article point to the high default rate on student loans (which hovers around 14%), claiming that the default rate may hit a breaking point, and the high level of federal lending will leave taxpayers to front a massive bill.  But that default rate is skewed by students of for-profit colleges, who take out (and default on) loans at a higher rate than the rest of the population.  And said colleges will soon be facing new regulations effective this July, per the Washington Post, meant to limit the amount of debt their students accrue.  This reform will have a huge impact on the riskiness of the government’s student debt holdings – as the article mentions, students at for-profit schools “represent only about 11 percent of the total higher-education population but 44 percent of all federal student loan defaults.”

Regardless of the risk that taxpayers may have to front a bill for a student loan default crisis, one cannot deny the necessity of educating our nation’s populace.  Critics argue that not every citizen should decide to attend college by default, claiming that college isn’t worth it for everybody as tuition continues to rise.  But a study conducted by the Brookings Institute indicates that the income of college graduates has kept in pace with the increase in debt loads: between 1992 and 2010, the annual income of an average household with student debt increased by $7,400 while their debt burden increased by $18,000, meaning that the student debt essentially pays for itself with increased income in about two and a half years.  As we look towards a future where competition is fierce due to global competition and low-skill jobs will begin to disappear to sophisticated machines, it’s important that our country provides as much opportunity as possible to hopeful students in securing the means necessary to receive a higher education.

Housing Prices and Monetary Policy: The Long View

A long 140 year history on housing prices and interest rates provides evidence that lower short term interest rates have significant positive effects on mortgage borrowing and housing prices. These findings by Oscar Jorda, Moritz Schularick, and Alan Taylor pose a dilemma for monetary policymakers: should they prioritize restoring nominal GDP or trying to prevent housing bubbles? This is well illustrated by the front page of the digital WSJ at the time of writing: while the Fed considers how long it should continue keeping rates low, there are signs that subprime lending is expanding again.

Should Monetary Policy Respond to Financial Stability?

I have written before on what I think about the role of monetary policy authorities and financial stability. I am skeptical of the direct role of monetary policy for three reasons:

First, there’s no reason to believe that the Fed can accurately identify bubbles in advance. Second, even if a bubble appears, it’s not clear that raising short term interest rates could pop it. Third, even if monetary policy ends up bringing asset prices down, it is likely to do so only through hurting the livelihoods of average Americans.

In the article, I walk through a variety of historical examples including the Great Recession, the recession of 1937, and the Great Depression.

I still stand by the arguments I made in the article and want to offer several extensions. Note that I mean to criticize the idea that monetary policy should lean against financial bubbles — not the more general idea that central banks can play a role through macroprudential policies.

  1. The Swedish experience with raising rates in order to bring down debt levels has been a disaster. Instead of lowering debt to gdp ratios, tighter monetary policy instead reduced nominal incomes and caused debt to rise as a percentage of GDP.
  2. Lower rates are usually not a sign that monetary policy has been easy, but rather that it has been too tight. Low rates are typically a sign that demand is low, and as such central banks should try to lower rates even further in order to stimulate demand. If instead you try to raise rates too soon, by cutting off demand you just extend the period of low rates.
  3. There may be structural reasons to believe that housing prices tend to be higher when aggregate demand is low. Capital equipment, which is much more sensitive to the business cycle, become less attractive at every interest rate relative to houses. As such if central banks want to head off a housing bubble they may be better off ensuring rates are low enough to stimulate demand.

It’s also not clear that Jorda et. al. can get much traction on the types of monetary policy decisions facing much of the developed world right now. In their statistical approach, they identify exogenous variations in interest rates with falling interest rates from abroad that get passed through as a result of a fixed exchange rate and free capital flows. In other words, their monetary policy does not come from a domestic central banker deciding to ease instead of tighten, instead it comes from a decision from a foreign central bank.

This opens up the possibility that what they’re really identifying is unwanted expansionary monetary shocks when the economy is already booming, or the potentially destabilizing effects of rapid foreign inflows of capital. Neither of these are quite appropriate for central banks right now:

  1. The United States, for example, is sluggishly chugging along — hardly a boom time in which bubbles are started. The authors tell a Eurozone parable and explain how easy ECB monetary policy for Spain caused a property bubble. But even here we see this timing issue in effect — even if low rates in a boom cause asset prices to rise while doing little for output, the same may not be true in a slump.
  2. If the negative rate shock comes from a domestic source, that would mean that capital flows out to chase yields elsewhere . This is the exact opposite of what would be going on to the countries in the Jorda et. al. dataset.

Congress Needs to Rethink the Puerto Rican Economy

Last year, Standard and Poor’s became the first of the three major ratings agencies to downgrade Puerto Rico’s debt from investment grade to junk status, increasing pressure on the commonwealth’s government to find a solution to growing liquidity risks.  The US territory found itself facing a cash flow shortage, namely as a result of its habit for issuing debt to cover old debt, a practice that various administrations have been utilizing since 1976, according to Puerto Rican newspaper El Nuevo Día.  This combined with nine consecutive years of recession have left the island with some $70 billion of debt that it does not have sufficient revenue to service.

Friday, a US federal court ruled that Puerto Rico’s Recovery Act, a bill passed last June that would allow the commonwealth’s public corporations to restructure their debt, was unconstitutional, per Reuters. This ruling has left the Puerto Rican government in limbo as it has practically no way to organize its debt in the face of an inevitable bankruptcy.  Perhaps in anticipation of this situation, Puerto Rico’s sole representative in Congress, Pedro Pierluisi, proposed a bill that would allow Puerto Rico to be eligible Chapter 9 bankruptcy just a month after passing the Recovery Act.  This is certainly the most logical solution – US bankruptcy code defines municipality as “political subdivision or public agency or instrumentality of a State” (Wiki), and Puerto Rico’s state companies are definitely public agencies subject to US law.  However, US lawmakers have little incentive to act on a bill that would directly lead to the largest municipal bankruptcy in the nation’s history, so the bill died in committee (Congressional Bill Tracker).  This brings us back to Puerto Rico’s limbo.  As a US territory, it has no options available to it for restructuring its debt.

It is neither wise nor fair for US lawmakers to sit by and watch as the Puerto Rican economy, composed of US citizens, starves.  The Chapter 9 Uniformity Act, which may not even become reality in the foreseeable future, should have been a no-brainer and the first step towards a fundamental re-evaluation of the Puerto Rican economy.  While Puerto Rican’s administrations are by no means blameless, the root of many of the island’s economic troubles lie with US legislation.

The Puerto Rican government’s over-reliance on debt issuance is partially fueled by the fact that its debt is triple tax exempt, i.e. exempt from federal, state, and local income taxes.  This has made the commonwealth’s debt very appealing to wealthy Americans, and has ensured that Puerto Rico has never had much difficulty issuing debt despite underlying financial problems.  The Jones Act of 1920 prevents foreign ships from shipping cargo between two US ports, which prevents major cargo ships from stopping in Puerto Rico to unload goods and load Puerto Rican goods, as they opt for the mainland.  “Puerto Rican consumers ultimately bear the expense of transporting goods again across the Atlantic and Caribbean Sea on US-flagged ships subject to the extremely high operating costs imposed by the Jones Act” (Wiki).  There was also section 936 of the IRS code, which allowed corporations based in Puerto Rico to avoid income taxes.  The island’s economy grew based on corporations attracted by this exemption, and when the exemption expired the companies left, sparking the current nine year recession.

The US is obligated to reconsider its ties to Puerto Rico’s economy.  It should remove antiquated laws like the Jones Act.  It should work with the Puerto Rican government to work on running a tighter budget by improving the efficiency of public companies as well as tax collection rates.  I would even propose that the US backs all Puerto Rican debt, which I see to be a logical responsibility of a parent nation.

Whose Moral Hazard?

If you think of the Greek debt crisis as a result of “irresponsible lending” instead of irresponsible borrowing, the implications of a Greek default for “moral hazard” change. A debt write down would not just be seen as a bailout, but as a rational adjustment that allows a better allocation of risk between borrowers and lenders.

The conventional wisdom is that Greece overborrowed from bond markets. They lived beyond their means and the chickens are now coming home to roost. As such, allowing a partial Greek default would encourage future prolifigacy. Instead, the troika should hold Greece to their debt promises so as to prevent future moral hazard.

But another way of looking at it is to ask: “who the hell decided to lend to Greece at German-like interest rates”? Even as late as October 2008, the yield spread between Greek and German 10 year debt was under 1%. In the context of a longer history of interest rates, this was absurd. Reinhart and Rogoff’s history of financial crises shows that Greece has been in default for roughly 50% of its history since independence in 1830*!

Under this framework, the debt deal in 2012 was a massive bailout for non-Greek banks. When governments stepped in, private banks had the chance to offload their holdings of Greek debt.

So instead of considering how a Greek bailout will affect the Greek government’s willingness to borrow, think about what a bailout would mean for those investors lending to Greece. Leaving all of the creditors whole could be seen as encouraging international investors to not worry about bond spreads between Eurozone countries. This is yet another form of moral hazard. A failure to write off debt would be a sign that debt repayment will be prioritized over economic growth in future negotiations. This would signal to creditors that they can reach for yield even if they think that low bond yields on potential troublemakers such as Greece are not sustainable.

Instead of insisting on austerity, the move should be to write off debt and then implement substantially higher capital buffers on Eurozone banks. Both steps are important. First, a partial debt write off would allow Greece to get back on its feet. Austerity, instead of substantially reducing Greece’s debt to gdp ratio, has instead caused the debt burden to rise as spending cuts savage the real side of the economy. History shows that these large debt burdens are almost always resolved by either inflation or restructuring. And so instead of letting the suffering drag on, creditors should recognize that the full debt will not be repaid.

Second, higher equity requirements on Eurozone banks would make them better able to withstand a haircut if such debt problems arise again in the future. In addition, this would make the shareholders in the banks bear the burden of overly risky investment decisions, such as buying Greek debt at only a 1% yield premium relative to German debt. As such, it would have the additional effect of disallowing Greece access to excessive amounts of cheap credit in the future.

In effect, instead of focusing on moral hazard from borrowers, this proposal would resolve the pervasive incentives for lenders to buy government debt that they expect to be bailed out.

This approach is better than forcing the burden of adjustment exclusively on the borrowing country. Sovereigns face a diabolic loop in which economic weakness makes debt repayment more difficult, thereby creating a sovereign debt crisis that further damages economic growth. Pressing these countries to pay up when growth is weak threatens to send the situation out of control. Instead, banks should be responsible for appropriate funding structures that allow them to share in the burden of adjustment.

Moralizing is unproductive in a debt crisis. Instead of trying to punish Greece, the conversation should shift towards debt write-offs and higher equity requirements in an effort to restore current growth and establish a more rational risk division for the future.

Germany’s GDP Linked Debt

A recent proposal from the Greek finance minister includes a debt for equity swap, replacing some of the existing bonds with growth linked bonds that will only pay coupons if Greece grows. The stock market certainly liked it. After the news was announced the Athens stock market shot up 11% and the country’s bank stocks were up 18%..

But Germany’s experience with GDP linked debt should give Greece some caution about the potential political ramifications of GDP linked debt. I am referring to, of course, is Germany’s reparations burden after World War II. The German experience should serve as a reminder that if GDP linked debt is to work, it requires the good will of both creditors and debtors to encourage macroeconomic policies that help the debt get paid.

After World War I, the treaty of Versailles imposed an extremely harsh reparations payment on the German government. The numbers make the Greek situation of having to raise primary surpluses by a few percent look trivial. As noted in Barry Eichengreen’s classic “Golden Fetters”, the total reparations bill for Germany totaled 132 billion gold marks — over 4 times national income at that time. Around 50 billion of that burden was to be paid unconditionally, with initial payments around 10% of national income.

The other 80 billion was linked to the economic recovery of Germany. As such, around 60% of the new external debt burden was GDP linked.

This created a poisonous dynamic in German politics as officials knew that much of the fruits of their economic reforms would be sent abroad. As Barry Eichengreen writes:

“By linking reparations payments to the condition of the German economy, the Allies diminished the incentive for German policymakers to put their domestic house in order. Hyperinflation was only the most dramatic illustration. Politicians were not encouraged to implement painful programs designed to promote growth by the knowledge that the fruits of their labor would be transfered abroad.”

The German situation was not helped when the allied nations raised trade barriers in the wake of World War I. By definition, if Germany was to run a capital deficit and pay these reparations, then by definition it must also run a trade surplus. But since Allied nations were unwilling to allow dramatically greater German competition in what were already intensely competitive industries, the only alternative for Germany was to endure a severe internal devaluation in an effort to restore competitiveness and have funds to send abroad.

Now, I am not trying to draw an equivalence between German reparations payments — which were forced upon the country—and the Greek government’s debt—which was voluntarily accumulated. But I do want to use Germany’s interwar experience to sound out two potential concerns about GDP linked debt:

  1. It can have toxic effects on domestic politics. Politicians are unlikely to make sacrifices to shore up growth when a substantial part of the marginal benefit will be going to bondholders abroad.
  2. It’s useless without supportive policies from abroad. Even when more than half of the reparations bill was at stake, Allied nations were unwilling to ease trade conditions to ease the German reparations burden. In the current context, unless there’s support from the ECB to raise nominal GDP across the Eurozone, Greece’s debt burden will continue to be massive relative to the underlying nominal size of the economy.

Cross-listed on Medium

Growing Pile of Student Debt Poses Threat to Future US Economic Growth

The United States prides itself on the value it places on higher education.  The nation was recently ranked the fifth most educated country in the world, according to data collected by the Organization for Economic Co-operation and Development, using percentage of the population that has attained a tertiary education as their metric.  However, the data presents a more troubling story than it would appear at first glance.  When the OECD set its age range for the rankings, it was surveying the US population that fell between the ages of 25 and 64, yielding the 42% tertiary education attainment rate that places the United States so high in global education rankings.  However, if the age range is tightened to individuals between the ages of 25 and 34, which OECD uses to survey the “younger adults” population group, the US yields the same rate, 42%, and falls in the rankings all the way down to 14th.  The message here is clear: the United States may still be a leader in education, but it won’t be for long, as the nation is falling behind in the brains race.

Perhaps one of the biggest barriers to the United States keeping up with other leading nations in education its populace is the rapidly rising cost of higher education.  As shown in this analysis conducted by Bloomberg with data from the Bureau of Labor Statistics, the cost of college tuition in the United States has risen by a jaw-dropping 1,225% in the last 36 years – compared to a 279% increase in the consumer price index.  Higher education has been by far the most rapidly rising expense to American consumers in the past several decades, and it has left a massive burden on the shoulders of our country’s young population.

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While European countries are pumping out higher education at little to no cost to their students, thanks to state-subsidized public universities, American students are assuming student loans that will cripple their ability to contribute to the economy for years to come.  Mitchell E. Davis, the President of Purdue University, presents some more worrisome statistics in the Wall Street Journal, such as the fact that educational debt has become the second largest debt category for the American public, after home mortgages, and the fact that 25% to 40% of student borrowers report postponing major purchases such as homes and cars.  The most shocking statistic, for me at least, is this one: 45% of graduates age 24 and below are currently living at home or with some sort of family member.  Not only is this disheartening as a soon-to-be graduate, but it is troubling as a US citizen.  Young Americans are currently dragging down the US economy by avoiding major spending and by starting families later and later, they are dampening potential for economic growth.  The issue will continue to worsen as the pool of Americans with college debt grows, and will not be resolved until measures are taken to reform the higher education system and make learning more available to all citizens.

Should Margin Accounts be Eliminated?

When preparing to write this blog post I stumbled upon an article by Jason Zweig from The Wall Street Journal titled The Accidental Debt That Wouldn’t Die. This caught my attention immediately, primarily due to the fear it instilled in me. Debt is typically not a good thing, although it can be useful when firms are trying to raise capital, and are facing some sort of liquidity constraint. Debt that will not die seems even worse, and the fact that it was not intentional might be the scariest part of it all.

The accidental debt that this article is referring to was generated by the use of Margin Accounts. Like most people, I had no idea what a Margin Account was or how it worked. Luckily Investopedia can shed some light on this issue.

According to Investopedia, a Margin Account is “A brokerage account in which the broker lends the customer cash to purchase securities. The loan in the account is collateralized by the securities and cash. If the value of the stock drops sufficiently, the account holder will be required to deposit more cash or sell a portion of the stock” (Investopedia.com).

This is all fine and dandy, as long as the value of the securities that are used as collateral does not drop significantly.

“In an account that permits the use of margin, you can borrow against the market value of most stocks, bonds, mutual funds or exchange-traded funds. That enables you to leverage a smaller position into a bigger one. If your holdings do well, the margin will magnify your gains” (Zweig, 2015).

Okay, okay. I like the sound of that. Magnifying my gains is something I would enjoy.

“… A margin loan is secured by your investments. If they drop sharply in price, the brokerage firm can invoke a “margin call,” triggering a forcible sale to ensure that the firm will be able to get its money back on the loan it made to you. So margin can magnify your losses” (Zweig, 2015).

This, however, I do not like the sound of.

This seems to be a situation that involves moral hazard. “Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost” (The Economic Times).

The lender may make more risky loans knowing that they can simply invoke a margin call like mentioned above, causing the borrower to bear the entire loss. With seemingly little risk from the perspective of the lender, I believe this creates an incentive for the lender to offer margin loans that is not in the best interest of the borrower. The lender has an incentive to encourage people to leverage securities that they cannot afford to lose. This high risk, from the perspective of the borrower, I believe makes Margin Accounts a dangerous financial instrument. So dangerous that, I believe, Margin Accounts should be altered to increase safety, or eliminated all together.

Citations:

http://blogs.wsj.com/moneybeat/2015/01/23/the-accidental-debt-that-wouldnt-die/

http://www.investopedia.com/terms/m/marginaccount.asp

http://economictimes.indiatimes.com/definition/moral-hazard

What Greece Government Should Think about

The possibility of Grexit has been like dark clouds hanging above heads of financial institutions and people concerning this issue. Potential problems such as inflation, bank run, default risk and loss of competitiveness make “Grexit or not” a vital battle.

To keep a smooth international trade just as time before Grexit, Greece government should manage to maintain the resemble trading environment, i.e. to keep the advantages unified currency brought about, such as minimal transaction barriers and elimination of cost of trade. Substantial internal devaluation in Greece generated a small export boost, however, the regain of competitive led to an even excess export demand in Spain, Portugal, Ireland and Italy. Therefore, the international trade shock due to Grexit cannot be overlooked.

In order to achieve low target inflation and a relative fixed exchange rate against US dollar, Euro and Swiss Franc short after Grexit, the central bank of Greece should guard an interest rate close to major countries in Eurozone to shocks of hot money. The inflation is more likely to occur due to the pressure on printing money for recapitalize the banking system to guarantee a normal banking liquidity. The sour of quantity of Greek drachma will intensify the pressure on fixed exchange rate policy and the demand for Euro could drain the bank out of currency. Exchange control may help this problem.

Foreign investors are the primary hope of Greece to survive out of the swamp. The bailout program with the European Central Bank, the European Commission and International Monetary Fund will expire at the end of February after Prime Minister Antonis Samaras secured a two-month extension in December. Obtaining confidence from foreign investors decides the backup inflow of funds, and especially for the debt redemption and the repayment of principal. Inevitably, the success in the approaching vote and sustaining a situation under control will be the life-or-death bet. If the policy and tendency under the new government is not in favor of foreign investors, Greece should find out new ways to boost the economy.

No one knows how the situation will walk to; it is possible that Greece can hardly default its debt. Due to the fear of default risk, the real interest rate in Greece could be high, which will lead to high interest rate risk for banks and corporates who hold bond portfolios and loans. Financial institutes should carry out pressure tests with respect to interest rate risk in order to keep a steady and predictable cash flow.

Reflections on Reinhart and Rogoff I: Why Time Series Aren’t Enough

After crunching Reinhart and Rogoff’s data, we’ve concluded that high debt does not slow growth. That was the conclusion of a joint Quartz article with Miles Kimball in which we looked at post war data on sovereign debt and growth in advanced economies. Miles’ recent foray back into the debate made me reflect upon our previous work together.

Upon further reflection, I’m not sure I still believe in that title. Not because I now believe that debt to GDP ratios above 90% slow growth, but rather because I’m unsure if long time series provide meaningful information about the effect of debt on growth at all. Given the rarity of high debt episodes, time series data is either too sparse or takes data from drastically different policy regimes to be reliable.

Below is a plot of the overall paths of debt/GDP ratios in countries that passed the 90% threshold after winding down war debts. There are only 5 countries: Belgium, Greece, Ireland, Italy, and Japan (Note that the US is not included as the sample ends in 2009).

Therefore the sentence “whenever a country has hit 90% of debt to GDP” can easily be replaced by the phrase “when these handful of countries hit 90% of GDP in these specific years”.

This does not bode well for inference. One could look at each of these countries and provide a highly idiosyncratic story for why debt blew up and growth lagged. Japan was a story of fiscal policy in a liquidity trap. Greece was a story of “macroeconomic populism” in a time of stagflation. You might have specific beliefs about the governments in each of these countries, above and beyond their attitudes towards debt. These idiosyncratic components matter a lot, and as such there is no power (in the statistical sense) to detect a negative association between debt and growth. Indeed, growth was all over the place. Ireland boomed, Japan stalled, and the others were in the middle.

The fact that debt is very slow moving also means that when you compare different levels of debt and subsequent growth rates, you’re looking at very different time periods. Ashok states this forcefully after my article with Miles:

This means comparisons on different levels of debt take place on very different economic structures. When we talk about the America with 30% debt-to-annual-GDP (the first bin in R-R), we’re talking about an America before modern floating exchange rates, strong unions, extremely high taxes, and declining inequality — each of which adjusts the causal mechanism in question.

This problems caused by looking at such diverse time periods get worse if you try to look at even older data. To deal with the rarity of high debt episodes, Reinhart and Rogoff look all the way back to the 1800’s. But macroeconomic institutions were very different back then! For starters, countercyclical fiscal policy and fiat currencies were not nearly as prominent. Yet these are two critical issues that would change the way debt affects predictions of growth.

In a world of countercyclical fiscal policy (i.e. stimulus packages), rapid onsets of debt coincide with policies that induce more growth in the future. If instead debt is not associated with fiscal policy, then increases in debt are likely from exogenous factors that are worse for future growth. Recent experience with the Eurozone also suggests that having your own currency has tremendous effects on whether high debt levels are associated with financial distress. If there’s no monetary authority to backstop the debt, then increases in debt truly might have large negative effects on growth.

So if you have a strong prior that fiscal and monetary policies matter for the relationship between debt and growth (as I do), then thousands of observations from the Gold Standard era are nonetheless uninformative about how much current observed levels of debt matter for future growth.

But the entire question of causality remains unresolved! If governments are incompetent along many dimensions, debt being only one, then the association between debt and growth might just be a matter of generally incompetent governance. Without a proper instrument for debt, these long time series say nothing about how much high debt levels actually hurt growth. The time series evidence provides no guidance on how to weigh the cost of debt against the benefits of countercyclical fiscal policies.

So is there any way out? I think the answer has to lie not with bigger data sets, but rather theory and smaller case studies that help us shed light on potential mechanisms between debt and growth. For example, Krugman emphasized in his 2013 IMF seminar that the effect of debt depends crucially on whether the sovereign is borrowing in its own currency. Externally denominated debt puts a constraint on monetary policy. Therefore the effects of debt on growth might depend on whether monetary policy is still able to operate. This played out dramatically in the 1997 East Asian debt crisis. Crises near the end of the interwar Gold Standard also highlighted what can go wrong when central banks are forced to allow deflation that raises the real value of debts.

These examples suggest that debt buildups in countries such as the US or the UK are unlikely to pose major risks in the short run while debt buildups in countries without independent monetary policies — such as Greece, Italy, or Spain — are. With a more in depth analysis of theory and mechanisms, more recent examples from modern economic regimes can provide better guidance for policy.

Crosslinked from medium.