Expert Commentary

Dealing with debt: Historical evidence of governments’ actions and their effectiveness

2015 study by Harvard and the American Enterprise Institute that examines the range of options governments have used to manage their levels of public debt.

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The 2007-08 financial crisis is years in the past, but in many ways it is still with us: While some countries have returned to modest levels of economic growth, many households, companies and governments still face high levels of debt.

In politics, government debt remains the subject of vigorous debate, from extensive efforts by the European Union to tackle the Greek debt crisis, to self-imposed spending cuts — so-called “austerity” measures — in countries such as the United Kingdom and budget standoffs in the United States. A June 2015 report by the International Monetary Fund (IMF) argues that for countries not at risk of a fiscal crisis, actions to reduce debt below an arbitrary threshold can do more harm than good. There are also strong voices, such as the economist Paul Krugman, who argue that debt is poorly understood even by policymakers.

A 2015 study, “Dealing with Debt,” authored by Harvard economists Carmen Reinhart and Kenneth Rogoff and Vincent Reinhart, a visiting scholar at the American Enterprise Institute, seeks to lay out the full range of options for governments seeking to manage their public debt. The authors divide these options into two categories: First, “orthodox” strategies, most often cited by governments and international financial organizations, including enhancing growth and privatizing government assets. Second, “heterodox” strategies, including restructuring debt contracts, generating inflation and taxing wealth. Using historical data from 22 developed economies over the period 1800-2014, the paper explores the frequency and effectiveness of these different strategies.

The study’s findings include:

  • The average aggregate debt-to-GDP ratio for the 22 countries in the study was 63.3%. Debt levels as a proportion of GDP peaked during three distinct periods: After the Napoleonic wars; after World War II; and during the current period.
  • There were six episodes where, on aggregate, the debt-to-GDP ratio fell by a significant amount. The authors defined these episodes of “debt reversal” as a reduction in the debt-to-GDP ratio of 15 percentage points or more over a rolling period of five years.
  • Among individual countries, multiple episodes of debt reversal were not uncommon; four of the 22 countries had five or more debt reversals since 1800. Only the United States experienced a single reversal of debt, after World War II. However this reversal was particularly large, with the debt-to-GDP ratio reduced by more than 50 percentage points. In contrast, colonial empires experienced the most debt reversals, notably the U.K. and the Netherlands, with six distinct episodes each.
  • Large debt reductions were also not uncommon — over half the episodes in the study reduced debt by 25 percentage points or more of nominal GDP. In seven cases nations worked off more than the level of their nominal GDP.
  • The 70 different episodes of debt reduction included in the study are divided into two categories: the 36 that occurred immediately postwar; and another 34 in peacetime. Postwar debt is typically eroded through a combination of above-average inflation and below-average interest rates. This suggests an important role for “financial repression” in postwar periods, where government regulation allows them to take advantage of unusually low interest rates, before the private sector catches up with the effects of high inflation.
  • Peacetime progress to reduce debt normally comes from running larger-than-normal primary budget surpluses. This is typically a slow and incremental process to pay down government debt.
  • The most rapid reductions in debt occurred following bursts of inflation, most notably during hyperinflation in Germany during the 1920s. In about a quarter of episodes, some form of debt restructuring took place.
  • It appears to be incredibly difficult to pay down debt when inflation is low or negative — the data show that only 3% of episodes of debt reduction have taken place during periods of deflation.

The authors find that the seemingly preferred method of most advanced economies and global institutions today — the reliance on strong economic growth rates alone — is unlikely to be able to bring down such exceptionally high levels of debt. In the past, advanced economies have used a diverse range of strategies to bring down debt levels, including debt restructuring, inflation and financial repression — a much wider range of options than the nature of the current debate would suggest.

Related research: Harvard’s Reinhart and Christopher Trebesch of the University of Munich have also published a complementary 2015 paper, “Sovereign Debt Relief and its Aftermath,” which finds the following: “The resolution of debt overhangs in advanced and emerging market economies has much in common — even when they are separated by more than half a century. Both developed and less developed countries resorted to default and restructuring in economically hard times, and the magnitudes of debt relief delivered are comparable. We also find that the debt crises in both advanced and emerging countries have been protracted and cumbersome, often spanning more than 10 years.”


Keywords: austerity, financial crisis, economy, public debt, debt reversals, restructuring, financial repression, inflation, wealth taxes, privatization, austerity

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