Given the growing perception that monetary policy is losing its power to solve the world’s economic problems, is it time for central banks and governments to reach for more unconventional methods to bolster growth?
With global debt levels very high and rising, growth is likely to remain sluggish at best for years to come.
So how do we deal with this? In theory, there are four ways to reduce debt concerns: cutting funding costs, paying off the debt, growing our way out of the debt and writing the debt off.
However, there are problems with all of these options.
The idea in practice
First, with interest rates already extremely low, cutting funding costs much further is difficult.
Second, if everybody tries to pay off their debt it would reduce spending and investment, undermining demand, corporate revenue and economic growth. This can lead to a negative spiral, especially if it incurs deflation (or falling prices) which increases the debt burden of borrowers in inflation-adjusted terms.
Third, the high debt levels make it very hard to grow our way out of debt. As we have seen global growth has stayed sluggish and inflation benign, despite extraordinarily strong monetary policy stimulus. Meanwhile, fiscal policy stimulus may not be sufficient to create growth and/or inflation. In fact, such a route may burden the economy with more debt, bringing the problems back to square one. This leaves us with the last option – that of debt write-offs.
Historically, this has been done by governments defaulting on their debt obligations. Argentina and Greece have been serial defaulters, and the pain that this causes to the economies is clear for all to see.
"What is to stop a central bank from writing off the debt that it is owed?"
However, one idea that is getting some airtime, but is not yet being taken seriously, is that of debt forgiveness, rather than default. This may sound crazy: who in their right mind would lend somebody money and then say that there is no need to pay them back? But if we think about who owns this debt, then the idea becomes less fanciful.
Years of quantitative easing by the developed economies have resulted in a lot of government debt being owned by central banks with theoretically unlimited access to money (through their control of the printing presses). What is to stop a central bank from writing off the debt that it is owed?
The tipping point
In practice, there are, of course, significant constraints: it is likely to be politically unpalatable and there may be genuine fears that doing so could spark uncontrollable inflation – direct monetary financing of government deficits rarely end well.
But one has to believe there is a potential tipping point at which the downside risks of such action (hyperinflation, or at least much higher inflation) is less than the downside risks of inaction – a depression. After all, central bankers have better tools to control inflation than they do to fight deflation.
"If the Bank of Japan were to write off significant chunks of government debt, it would eradicate the need for fiscal consolidation"
Are we there yet? Clearly not. No central bank is seriously considering such action. Japan is probably closest – its economy and inflation are currently faltering and the Japanese yen rallying despite massive amounts of monetary stimulus. Would more bond and equity purchases, or more deeply negative interest rates, really help? I doubt it. But if the Bank of Japan were to write off significant chunks of government debt, it would eradicate the need for fiscal consolidation and take the brakes off the economy.
Clearly, longer term, the real answer to the world’s problems is economic reform, both in the developed and the emerging world, boosting productivity, reducing inequality and raising overall demand for goods and services. But reforms take time to deliver. Meanwhile, a debt write-off may buy significant time for the authorities to implement innovative measures to increase supply-side efficiency and revive global growth.