Martin Wolf on how to address the private debt problem

Keep in mind Wolf is addressing the de-leveraging of private debt, not public debt, which usually gets all the headlines. But to me public debt is not nearly as complex a problem as it is made out to be, due to the remarkable privileges enjoyed by the Federal Reserve and US treasury. The US has institutions that can finance its own sovereign debt. I don’t think the US has built-in institutions to take care of its private debt problems. Though perhaps I am wrong. Regardless, here Wolf talks about ways to address the private debt problem (link). The following is an excerpt on inflation and deficit spending as key tools:

An alternative way of delivering the equivalent of a mass default is, of course, inflation, now recommended by several economists: see The housing market and the case for higher inflation targets in the US and the Eurozone and The bullets yet to be fired to stop the crisis. Inflation can, of course, deliver negative real interest rates, thereby encouraging investment in real assets. More important, it can lower the value of debt relative to the price of assets quite quickly, above all where nominal interest rates are fixed long term (as is the case in US mortgage finance).

Obviously, this would damage the prudent saver. But so, it should be stressed, would mass bankruptcy. Claims that cannot be enforced have to be written down in one way or the other, as my colleague Martin Sandbu, has just argued.

A question, however, is how to deliver somewhat higher inflation. In countries with deep slumps, inflation is not easy to deliver. Conventional quantitative easing does not seem to do the trick. Something more radical would be needed.

For relatively small economies, the easiest way of delivering higher inflation without destabilising expectations would be to set a (possibly steadily depreciating) ceiling against an anchor currency. Thus, I argued some 12 years ago, that Japan could set a value of 100 yen to the dollar as a ceiling. Over time, that would have raised its inflation to US levels. The Swiss Central Bank has done something very similar, in setting a ceiling against the euro. The UK could, in principle, follow a similar policy, probably again vis a vis the euro.

For a big country with a global currency, such as the US, exchange rate targeting seems inapposite. So the central bank might target other asset prices. In order to gain greater credibility for the new policy, it could adopt a new target – a price level target, for example, or a target for nominal GDP. But it would have to show determination in trying to hit this target.

All such policies should be regarded as complements to, not substitutes for, resort to the government’s balance sheet as a cushion for adjustment: in brief, we should accept large, temporary fiscal deficits as part of the price of returning the economy to health after the crisis.

This entry was posted in 2007-2012, macro-economics, money and finance, prices, the great contraction, the great contraction 2007-2012. Bookmark the permalink.

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