Growth in a Time of Debt

Written as public debt was climbing steeply in the wake of the 2007-2009 crisis, this paper asks what the long historical record says about growth and inflation at different levels of government and external debt. The approach is, in the authors’ own word, “decidedly empirical”: they assemble a new multi-country dataset on central government debt covering 44 countries over roughly two hundred years and more than 3,700 annual observations, sort every country-year into one of four debt-to-GDP brackets – below 30 percent, 30 to 60, 60 to 90, and above 90 – and compare average and median growth and inflation across the brackets. Three findings follow. First, for 20 advanced economies over 1946-2009, “there is no obvious link between debt and growth until public debt reaches a threshold of 90 percent,” above which median growth is “roughly 1 percent lower than the lower debt burden groups and mean levels of growth almost 4 percent lower”; extending the same exercise back over two centuries gives a very similar picture, with mean growth of 1.7 percent above 90 percent against 3.7 percent below 30 percent. Second, the public debt threshold is similar for 24 emerging markets: over 1900-2009, growth “hovers around 4-4.5 percent for levels of debt below 90 percent of GDP but median growth falls markedly to 2.9 percent for high debt (above 90 percent),” with average growth falling to 1 percent. Emerging markets, however, face a considerably tighter threshold on total gross external debt, which is almost entirely foreign-currency denominated: growth deteriorates markedly above 60 percent of GDP and declines outright above 90 percent, which the authors connect to the observation that “over one half of all defaults on external debt in emerging markets since 1970 occurred at levels of debt that would have met the Maastricht criteria of 60 percent or less.” Third, inflation and public debt show no apparent contemporaneous pattern for advanced economies as a group – with the United States a notable exception – while in emerging markets median inflation more than doubles, from under 7 percent to 16 percent, between the lowest and highest debt brackets, a pattern for which “fiscal dominance is a plausible interpretation.” The paper is consistently careful about what it is and is not claiming. It reports associations rather than estimated causal effects, deliberately declines to distinguish how debt was accumulated (“here we will not attempt to discriminate the genesis of debt buildups”), notes that the four brackets reflect “our interpretation of much of the literature and policy discussion” and that “sensitivity analysis involving a different set of debt cutoffs merits exploration,” reports that some countries – Australia and New Zealand among them – show no growth deterioration at very high debt while noting those observations cluster just after the Second World War, and treats the reason for a threshold at 90 percent as an open question it can only “speculate” about, via the earlier debt-intolerance argument that risk premia rise sharply as debt approaches historical limits. The closing sections add two forward-looking observations: advanced-economy external debt is now very high, averaging over 200 percent of GDP across advanced Europe, but the data begin only in 2003 so no threshold can be estimated for it; and private-sector deleveraging after a crisis, illustrated with US private debt to GDP over 1916-2009, is a separate channel through which growth may be dampened.

Sovereign Bonds Since Waterloo

The paper asks a question the sovereign debt literature has mostly approached from the borrower’s side: given how often governments default, why do investors keep buying their bonds? It answers by measuring what creditors actually earned, assembling two new datasets and matching them bond by bond. The first is monthly price quotations for 1,552 foreign-currency sovereign bonds issued and traded in London and New York between 1815 and 2016 – 266,134 observations covering up to 91 countries in an unbalanced panel. The second is an archive of external default and restructuring events built largely from the annual reports of nineteenth- and early-twentieth-century bondholder organisations, yielding haircut estimates for 313 restructuring events in 91 countries and, crucially, the timing and size of missed or partial coupon payments at monthly frequency. The central finding is that the average real ex-post yearly return on a global portfolio of external sovereign bonds was 6.85% – about 4 percentage points above the “risk-free” benchmark of long-term UK and US government bonds, with the excess return running 2% to 4% depending on the era. Two things make that survive the defaults. First, defaults do not wipe creditors out: the average haircut is 44% (39% when weighted by amount restructured), with a standard deviation of about 30% and no visible time trend across 200 years, and outright repudiation is confined to revolutions and imperial break-ups. Second, roughly 70% of the 8.0% average nominal return – 5.6 percentage points – comes from coupons rather than capital gains, so returns keep accruing even while prices are depressed. The risk is real and priced: bonds of the 51 “serial defaulters” earn the highest returns (7.1% real, 4.6% excess) and also the highest volatility; after a default the cumulative return index falls about 15%, and an investor entering two years before default breaks even about four years after it, though the lower quartile of episodes never recovers within six years. Compared with other asset classes over the same two centuries, only US equities and a 16-country advanced-economy equity portfolio returned more, while the external sovereign bond portfolio’s Sharpe ratio is on a par with US equities and above US corporate bonds, UK equities, and domestic sovereign bonds. The authors are explicit about the scope limits: the sample is unbalanced with a near-total gap in the 1970s and 1980s syndicated-bank-loan era, so the 1980s debt crisis is largely absent; and they caution that the unusually good modern performance should not be read as a “new normal.”

Carmen M Reinhart | Macro Paper Warehouse

Growth in a Time of Debt

Sovereign Bonds Since Waterloo