To understand this prescrip- tion, we have to comprehend the diagnosis. As Carmen Rein- hart and Kenneth Rogoff argue, recoveries from crises that result from over-leveraged balance sheets are slow and typically re- sistant to traditional macroeco- nomic stimulus. Over-levered households cannot spend, over- levered banks cannot lend, and over-levered governments can- not stimulate.
So, the prescription goes, why not generate higher inflation for a while? This will surprise fixed- income investors who agreed in the past to lend long term at low rates, bring down the real value of debt, and eliminate debt “overhang,“ thereby re-starting growth. It is an attractive solu- tion at first glance, but a closer look suggests cause for serious concern. Start with the question of whether central banks that have spent decades establishing and maintaining anti-inflation credibility can generate faster price growth in an environment of low interest rates. Japan tried--and failed.
Perhaps if a central bank an- nounced a higher inflation tar- get, and implemented a finan- cial-asset purchase programme (financed with unremunerated reserves) until the target were achieved, it could have some ef- fect. But it is more likely that the concept of a target would lose credibility once it became changeable. Market participants might conjecture that the pro- gramme would be abandoned once it reached an alarming size--and well before the target was achieved.
Moreover, the central bank needs rapid, sizeable inflation to bring down real debt values quickly--a slow increase in in- flation (especially if well sig- nalled by the central bank) would have limited effect, be- cause maturing debt would de- mand not only higher nominal rates, but also an inflation-risk premium to roll over claims.
Significant inflation might be hard to contain, however, espe- cially if the central bank loses credibility: Would the public re- ally believe that the central bank is willing to push interest rates sky high and kill growth in order to contain inflation, after it abandoned its earlier inflation target in order to foster growth?
Consider, next, whether the inflationary cure would work as advertised. Inflation would do little for entities with floating- rate liabilities (including the many households that borrowed towards the peak of the boom and are most under water) or relatively short-term liabilities (banks). Even the US govern- ment, with debt duration of about four years, would be un- likely to benefit much from an inflation surprise, unless it were huge. Meanwhile, the bulk of its obligations are social security and health care, which cannot be inflated away. Even for distressed house- holds that have borrowed long term, the effects of higher infla- tion are uncertain. What would help is if their nominal dispos- able income rose relative to their (fixed) debt service. Yet, with high levels of unemploy- ment likely to keep nominal wage growth relatively subdued, typical troubled households could be worse off.
Of course, any windfall to bor- rowers has to come from some- one else's wealth. Inflation would clearly make creditors worse off. Who are they? Some are rich people, but they also in- clude pensioners who moved into bonds as the stock market scared them away; banks that would have to be recapitalized; state pension funds that are al- ready in the red; and insurance companies that would have to default on their claims. In the best of all worlds, it would be foreigners with ample reserves who suffer the losses, but those investors might be needed to fi- nance future deficits. So central banks would have to regain an- ti-inflation credibility very soon after subjecting investors to a punishing inflation. In such a world, investors would have to be far more trusting than they are in this one.
This does not mean that noth- ing can be done about the debt problem. The US experienced debt crises periodically during the 19th century, and again dur- ing the Great Depression. Its re- sponse was to offer targeted and expedited debt relief.
In this vein, a recent proposal by Eric Posner and Luigi Zin- gales to facilitate mortgage-debt renegotiation would give a deeply underwater homeowner the right to file a pre-packaged Chapter 13 bankruptcy petition.
This would allow her to write down the value of her mortgage by the average house-price de- preciation in her postal zone since the borrowing date, in ex- change for giving the lender a share of the future house-price appreciation. A bankruptcy judge would approve the peti- tion, provided the court was sat- isfied that the homeowner could make the reduced payments.
Such automatic borrower-ini- tiated filings, if made legal by Congress, could reduce the household-debt overhang with- out the need for government subsidies. To the extent that the alternative is costly foreclosure proceedings that make borrow- ers and lenders worse off, this proposal should attract the sup- port of both sides.
No solution is without weak- nesses, though. One reason that banks oppose debt write-downs is that many underwater homeowners continue to repay debt rather than default, even while cutting back on other spending.
If these diligent payers are even- tually expected to default, writ- ing down their debt today makes sense. If they are expec- ted to muddle through, a blan- ket debt write-down would weaken banks and might slow economic growth. Policymakers espousing debt write-downs to spur growth should ask whether they have the political support to recapitalize banks if needed.
Prescriptions like these--as with those for a jolt of infla- tion--have gained ground be- cause the obvious solutions to economic stagnation have been tried and failed. But, as the pro- posals become more innovative and exotic, we must examine them carefully to ensure that they wouldn't end up making matters worse.
©2011/PROJECT SYNDICATE Raghuram Rajan is professor of finance at the University of Chicago's Booth School and au- thor of Fault Lines.
No comments:
Post a Comment