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Fiscal Crises and the Role of Monetary Policy

US Monetary Policy Forum,

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High sovereign debt levels can trap nations in a vicious circle of rising rates and growing debt.

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Editorial Rating

7

Qualities

  • Controversial
  • Analytical
  • Overview

Recommendation

How much government debt is too much? At what point does it cause an economy to spiral out of control? Four economists – David Greenlaw, James D. Hamilton, Peter Hooper and Frederic S. Mishkin – studied data from 20 developed nations over a 12-year period seeking to answer these difficult, dynamic questions. They explain the problem and its possible ramifications as well as the dismal science allows. Along with a math-heavy econometric analysis, the authors concisely interpret their findings for those who are statistically challenged. Though their conclusions and methodology have met with some pushback from other economists, this is an intelligent analysis of the broader situation. getAbstract recommends this report to economists, academics, financial professionals and government officials working on fiscal and monetary policy.

Summary

Remembering Days Without Debt

The current global debt crisis didn’t exist in the 1990s. At that time, the United States had a budget surplus. Even the poorer countries of Western Europe were shedding debt as a percentage of gross domestic product. This sanguine picture changed in 2008, however, when Lehman Brothers and other financial behemoths collapsed. The deep economic downturn that followed slashed revenues and sparked government spending in many nations. The bottom line: Sovereign debt has soared in most advanced nations, while central bankers pump up their balance sheets to historic levels to keep feeble economies going. The situation worsened in 2010, when sudden, sharp spikes in borrowing rates hit several European nations, leading to a fiscal crunch and the potential for economic disaster.

Today, many nations face the possibility of a vicious circle of higher government bond rates leading to higher debt. Understandably, their worried lenders are demanding that these countries pay premiums on their loans. But higher rates only increase a nation’s debt, leading to a tipping point at which rates soar and a Greek-style financial crisis develops. When this happens...

About the Authors

David Greenlaw is chief US fixed-income economist at Morgan Stanley. James D. Hamilton is an economics professor at the University of California at San Diego. Peter Hooper is chief economist at Deutsche Bank Securities. Frederic S. Mishkin is a banking professor at Columbia University.

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