Financial Crisis, Debasement Trade, and Fiscal and Monetary Policy Nexus Under High Government Debt
Author:GAO Zhanjun and Carmen M. Reinhart
In an exclusive interview with China Forex, professor Carmen M. Reinhart shared her insights with Dr. GAO Zhanjun, the Executive Editor-in-Chief of China Forex, on critical issues and frontiers in the field of international finance and macroeconomics.
Carmen M. Reinhart is the Minos A. Zombanakis Professor of the International Financial System at Harvard Kennedy School. From 2020-2022, she served as Senior Vice President and Chief Economist at The World Bank Group and was Chief Economist at the investment bank Bear Stearns in the 1980s. She was Policy Advisor and Deputy Director at the International Monetary Fund, a member of the Advisory Panel of the Federal Reserve Bank of New York and Congressional Budget Office Panel of Economic Advisors, among others. Her work has helped to inform the understanding of financial crises in both advanced economies and emerging markets (EMs). Her best-selling book (with Kenneth S. Rogoff) entitled This Time is Different: Eight Centuries of Financial Folly, documents the striking similarities of the recurring booms and busts that have characterized financial history. It has been translated into over 20 languages and won the Paul A. Samuelson Award. She is an elected member of the Group of Thirty and is a senior fellow at the Council on Foreign Relations.
Reinhart is ranked among the top economists worldwide according to Research Papers in Economics (RePEc). She has been listed among Bloomberg Markets Most Influential 50 in Finance, Foreign Policy's Top 100 Global Thinkers, and Thomson Reuters' The World's Most Influential Scientific Minds. In 2018, she was awarded the King Juan Carlos Prize in Economics and NABE's Adam Smith Award, among others.
This edited conversation highlights key issues and frontiers in the study of financial crisis, AI bubble, debasement trade, and theinteraction between fiscal and monetary policy under high government debt, among other critical topics.
Discussion 1
An illustrious career shaped by real-life events
Dr. Gao: It's a great delight and honor to have you today, Carmen, thank you very much. As a prominent economist specializing in international finance and macroeconomics, with a long and distinguished career devoted to the study of financial crises in both advanced and emerging market economies (EMEs), you have produced extraordinary and path-breaking work on sovereign debt crises, banking failures, capital flows, exchange rate regime shifts, among many other critical areas. Your research has greatly enhanced our understanding of the causes of financial collapse, provided valuable policy insights on how to prevent such crises from occurring in the first place, and offered effective solutions for addressing them when they do arise. What is particularly impressive is that your research has been deeply informed and driven by real-life events. I do like that. I'm confident that our conversation today will be wide-ranging and insightful. We will cover a variety of important topics. To begin with, I would be interested to learn what inspired you to enter and pursue research in this field.
Professor Reinhart: My first job after graduate school, before completing my PhD -- that is, with everything except my dissertation finished -- was at Bear Stearns on Wall Street. I started in March of 1982, and Mexico defaulted in August of 1982. Next to me at Bear Stearns was an analyst of US banks, which had huge exposures. I thought the man was having a heart attack in the office, given what the default meant for the creditors and for the banks. A whole wave of crisis followed Mexico, not just across Latin America, but also in the Philippines, Nigeria, Poland, among a whole range of defaults. And that, very early in my career, was a big trigger. Up until that time, the IMF involvement had been sketchy and limited to individual crisis. But this was the first time we were hit with a systemic crisis, so the IMF involvement took off. I therefore became very interested in the IMF and the multilateral institutions. I was born in Cuba, so I was always interested in international issues. There was no question that my work would be international, yet the crisis specifically shaped my path from very early on. Over four and a half years on Wall Street, I built a successful career and rose to become Bear Stearns' chief economist. However,success came at a cost: you had to spend more time with clients and less on research, which I did not particularly enjoy.
So, I resolved to finish my PhD, and returned to Columbia University, where I completed my dissertation in just nine months under Robert Mundell.
Dr. Gao: That's truly remarkable. Professor Mundell was a role model for so many of us.
Professor Reinhart: Yes, he was wonderful. He was great. At the time, given everything that had transpired, I was very interested in global commodity prices, because global commodity prices had collapsed when Chairman Paul Volcker of the Federal Reserve started to tighten monetary conditions in 1979. Commodity exporters were really hard hit, as it marked the most persistent commodity price collapse since the 1930s. So that became my dissertation on the international transmission of commodity shocks and their impacts. That's how I got started in financial crisis research. When I finished the dissertation, my professors, Bob Mundell, Ron Findlay, and Alberto Giovannini, encouraged me to enter academia to address real-world events and practical concerns. But I was fascinated with the IMF, so I decided to go there because a former professor of mine, Guillermo Calvo, who taught me at Columbia, was at the IMF as a senior adviser and I was delighted to go and work at the IMF. That's how I started doing research beyond my dissertation.
Dr. Gao: Before talking about your experience at the IMF, I'm particularly interested in how Professor Mundell influenced your research and career.
Professor Reinhart: Enormously! Bob was Canadian and thus truly international. I think US economists tend to gravitate, as a rule, more towards domestic macro. Bob was very interested at the time also in commodity prices and the connection of commodity prices to the global inflation cycle. So, we had a lot to talk about. He would rarely read anything, but I would sit with him. His apartment was very close to the university. I would go and sit with him and basically tell him what I had written, and that's how my dissertation came about. And he was great. His work on exchange rate regimes, on the transmission of international shocks, also were very driven by real-life events, so we had a lot to discuss, and it was fabulous, my dissertation experience with him was fabulous.
And Ron Findlay was great, too. Ron Findlay was born in Burma, now Myanmar. He was not so much on the financial side, but on the real side and on the trade side, and also very interested in commodities. So, I had wonderful inputs from my faculty mentors on my dissertation. And Guillermo Calvo also really shaped my work too. Guillermo is now very frail; he's in his 80s and he's not doing so well. We still talk frequently to this day.
Dr. Gao: Guillermo was at the IMF, at the time, wasn't he?
Professor Reinhart: He was. He had been at Columbia University. I had intended to do my dissertation with him, and with Maurice Obstfeld, but both Maurice and Guillermo had left Columbia to go to the University of Pennsylvania when I came back from Wall Street; they were no longer there. And so, we had not connected until we were together again at the IMF, long after he had been my professor at Columbia University. And Columbia University was really for internationalmacroeconomics, it was quite exceptional at that time, John Taylor was there focusing on macro, Guillermo Calvo, Bob Mundell. I was in Maurice Obstfeld's first class.
Dr. Gao: That's wonderful. Afterward, you joined the IMF.
Professor Reinhart: Yes, right after I finished my thesis, I joined the Fund in 1988 and went to the research department, and that's where my real interest in research flourished. If you had asked me what my career path would be when I was in college, I would have told you it would be a professor. But then I went to Columbia University where I met Vincent, and we got married, so I wanted financial stability, and Wall Street was a big pool; that's why I went to Wall Street even before I finished my Ph.D. dissertation. And Vincent was working at the Federal Reserve by then.
Dr. Gao: He had been with the Federal Reserve for many years.
Professor Reinhart: Yes, he had a career of 25 years at the Federal Reserve, first at the New York Fed, and then at the Board of Governors where he rose very quickly. He was one of the youngest directors of monetary affairs, he was Director of the Division of Monetary Affairs and Secretary and Economist of the Federal Open Market Committee (FOMC).
Dr. Gao: I read many of his papers.
Professor Reinhart: So that's a little bit of my trajectory.
Dr. Gao: You spent eight years at the Fund, all of which were in research department, right?
Professor Reinhart: Not entirely. Two things. One is that mobility is part of the IMF, and you're supposed to change departments. So, my last couple of years were in the Western Hemisphere Department. They really valued research, the management at the time, Claudio Loser and Ernesto Hernández-Catá, who was also Cuban, valued research a great deal. I was covering the US and Canada which meant you didn't have five missions a year, and so I had more time for research. My work with Graciela Kaminsky on the links between banking and currency crises (Graciela L. Kaminsky & Carmen M. Reinhart, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.), on leading indicators of currency crisis, is taking place importantly at the tail end of my stay in Research Department and then when I was in the Western Hemisphere Department. In the wake of the 1994 Mexican and 1997 Asian financial crisis, the subject of financial crises came to the forefront of academic and policy discussions. This paper analyzes the links between banking and currency crises. We find that: problems in the banking sector typically precede a currency crisis--the currency crisis deepens the banking crisis, activating a vicious spiral; financial liberalization often precedes banking crises. The anatomy of these episodes suggests that crises occur as the economy enters a recession, following a prolonged boom in economic activity that was fueled by credit, capital inflows and accompanied by an overvalued currency.
Dr. Gao: It is a seminal and highly influential paper in international finance. It established that banking and currency crises are often interconnected, with banking crises usually preceding and amplifying currency collapses, especially in liberalized economies.
Professor Reinhart: Right. But it was like in Wall Street, when you became more senior, then you had to do more administrative and operational work. So, I decided to go to academia. One reason I had not gone to academia sooner was that I was constrained geographically because Vincent was doing very well at the Federal Reserve: we have dual careers.
Dr. Gao: Vincent was at the New York Fed at that time, right?
Professor Reinhart: No, he was at the Federal Reserve Board, in Washington. We moved together in 1988 from New York to Washington, when he went to the Federal Reserve Board. He was having a great career. And so, I did get approached by various universities during that time period while I was at the IMF, but moving was not an option. So, it was when the University of Maryland approached me that I finally decided to move. Guillermo Calvo had left the Fund and gone to the University of Maryland, and then the University of Maryland approached me. That was fine, because it was all local. I didn't move out of D.C. until Vincent retired in mid-2007, preceding the acute phase of the 2008 financial crisis.But by then I had been at the University of Maryland for a good number of years, I went to Maryland in 1996.
During that time, I did some of my early work which you mentioned. One was capital flows. My very first sort of big topic was putting this into context in the very beginning of the 1990s when we had the Brady Plan and the debt restructuring and the debt write-offs eventually. After the decade-long debt crisis,capital started to flow back to EMs. And so, my work with Guillermo Calvo and Leonardo Leiderman was precisely about common global drivers of capital flows.（Calvo, Guillermo A., Leonardo Leiderman, and Carmen M. Reinhart. 1996. "Inflows of Capital to Developing Countries in the 1990s." Journal of Economic Perspectives 10 (2): 123–139.）At the time, the IMF argued that Mexico was attracting capital flows because of domestic reforms, but we looked at the evidence and pointed out that Brazil hadn't done reforms and they were getting capital flows.Columbia hadn't done that much; they didn't have a debt crisis. There was a global cycle, hence the emphasis on the global factors. And that was my first core topic. The research really took off, because to this day when people talk about the role of international interest rates, the role of global commodity prices, on capital flows, it often dates back to that work.
Dr. Gao: Exactly, it is highly influential. It pioneered the analysis of "push" vs. "pull" factors, demonstrating that global factors, like US interest rates, drove capital inflows, not just domestic policies. It established that capital flows led to real exchange rate appreciation and highlighted policy challenges like sterilization. Your work back then became the foundation of this sector.
You just mentioned the 1982 Mexican crisis and also the 1989 Brady Plan. As I recall, it was widely believed back then that sovereign governments would never default. Yet it seems that view has shifted significantly since.
Professor Reinhart: Look, people often use the word "unprecedented", and in my view, "unprecedented" often means "I don't know history". Some things are unprecedented, but in most common usage, what do people mean by unprecedented? It happened 20 years ago, or even five years ago. As I showed in one seminar, on one of the slides, we can see that the wave of defaults of the 1980s was the worst since the 1930s. The 1930s were worse, because the 1930s were not just EMs; they were also advanced economies. It had been 50 years since a similar global outbreak of that kind of crisis, and as I said, that had an enormous influence on my work. It also involved issues related to crises, obviously, like contagion, which I wrote about with Graciela Kaminsky.
Dr. Gao: On Crises, Contagion, and Confusion, that's the title of the paper, right? (Kaminsky, G. L., & Reinhart, C. M. (2000). On Crises, Contagion, and Confusion. Journal of International Economics, 51, 145-168.) This paper is highly influential, as it draws a clear distinction between crises stemming from common economic fundamentals and those driven by pure contagion operating through financial, trade, and banking links. It provides a framework for understanding how financial crises spread globally and guides policymakers on creating more resilient, stable international financial systems.
Professor Reinhart: Yes, you know it all. So, my fascination with these issues continues to this day. And during that time, Guillermo Calvo and I, both of us were in Maryland. On crises again, we noticed that EMs had been reluctant to allow their currencies to float freely, despite claiming to do so. We know that during the Mexican crisis, they said the exchange rates were floating, but it wasn't a fact, okay? They were not floating. The Philippines also had a currency crisis in the 1998 East Asian Crisis,and they said their exchange rate was floating, but it was not floating. So, tied to these issues, the article Fear of Floating, co-authored with Guillermo came out.
Dr. Gao: Yes, you and Guillermo Calvo pioneered the famous "fear of floating" concept. As I recall, the first draft of this paper was in 2000, and a revised version of this paper was published in Quarterly Journal of Economics in May of 2002. (Guillermo A. Calvo & Carmen M. Reinhart, 2000. Fear of Floating, NBER Working Papers 7993, National Bureau of Economic Research, Inc.) This seminal, highly cited study demonstrates that officially "floating" exchange rates often resemble non-credible, managed pegs, driven by the desire to avoid large fluctuations. You argue that many countries claiming to have floating exchange rates actually intervene heavily to limit volatility, often due to a lack of policy credibility.
Professor Reinhart: Yes. Although Ken and I had seen each other at conferences and so on, it was the paper Fear of Floating, I think, that really attracted his attention. We were together at a conference organized by Robert Barro and Alberto Alesina at Stanford, where I presented the paper Fear of Floating. This conference, entitled Currency Unions, was held at Stanford University's Hoover Institution in 2000, I guess. And then when Ken was offered the IMF positions of research director and chief economist, he said, why don't you come and be my deputy? I think it was lovely because I have always liked moving between academia and policy, as I did recently at the World Bank from 2020 to 2022. Besides, it didn't affect my personal situation in that we remained in Washington, right? Because Vincent was still at the Federal Reserve Board, and he was by now director of monetary affairs. So, I said sure, and that's when our collaboration started. And the very first project, which was closely related to Fear of Floating, was The Modern History of Exchange Rate Arrangements.
Discussion 2
This-time-is-different syndrome: predicting the occurrence of the crisis
Dr. Gao: Amazingly, in your seminal paper The Modern History of Exchange Rate Arrangements (Carmen M. Reinhart & Kenneth S. Rogoff, 2002. The Modern History of Exchange Rate Arrangements: A Reinterpretation, NBER Working Papers 8963.), you and Ken coined another term that later became very popular: "debt intolerance", which is defined as the inability of many EMEs to manage external debt levels that are considered manageable for advanced economies. This concept explains why some countries face defaults or severe financial distress at, or even below, a 35% debt-to-GDP threshold, due to a history of poor credit. This work indicates that these nations frequently enter crises with lower debt-to-GDP ratios than developed countries have done historically, highlighting that for some, a "safe" debt level is far lower than conventional wisdom suggests.
Professor Reinhart: We actually introduced two phrases in this paper: one is "debt intolerance", the other one is "serial default", which refers to countries that have defaulted more than two times. We dubbed that "serial default".
Dr. Gao: Yes, exactly. "Serial default" refers to the tendency of certain countries to repeatedly default on sovereign debt or restructure obligations over short periods, characterized by a cycle of borrowing and default. It is more common than generally believed, often occurring regardless of debt-to-GDP levels and linked to fiscal habits and shocks. For the past 180 years, some countries like Greece have been in default roughly half the time.
Professor Reinhart: Yes,I mean, for some countries, the misfortune is that, mostly in the 19th century, they would go into default and remain in default for 50 years. It's not like modern days, where we think of 10 or 15 years as a very long time, but 50 and 60 years is far longer. If you look at a country like Greece, which gained independence in 1830, it was in default for most of the 19th century. Not because it kept defaulting, but because that debt restructuring was one on one, highly ad hoc,and there was no international mechanism. So, countries like Greece and Mexico remained in default for many decades. Also, during the 19th century, you had a lot of countries engaged in nation-building, and there were also many internal wars going on that made restructuring difficult if not impossible.
But one of the things that I remember shocked people when we came out with "debt intolerance" is that we made the point: look, we think of defaults in the modern era as being strictly an emerging market phenomenon -- but that's not the case. Because if you go back, Spain holds the record with 12 defaults. This goes back to the 16th century, the period of Philip II; defaults became more common after he bankrupted Spain by invading England. What I'm getting at is the idea that defaults also happened in advanced economies which people forget, and this resurfaced big time with Greece. I'm not saying this now. I said it on record at an IMF conference at the time, when it was still believed that EU support and IMF support could avoid a default. And I said, "No, Greece's debt profile was going to require debt restructuring." I got a lot of push back because of this, and people said, "No, no, Greece was not like an emerging market." But in fact, Greece had a debt that even with the IMF and the EU support, was still going to require debt restructuring.
Dr. Gao: You said that at the IMF conference back in 2012, as I recall, right? (IMF Working Paper. Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, Carmen M. Reinhart and Kenneth S. Rogoff, December 2013. This paper was written for the IMF conference "Financial Crises: Causes, Consequences, and Policy Responses" held on September 14, 2012.)
Professor Reinhart: Yes. And Vincent and I wrote an op-ed at the time, I think it was in The Washington Post, precisely on this issue. We wrote that for Greece, debt restructuring was in the making long before it actually happened. (Carmen Reinhart and Vincent Reinhart, 5 Myths about the European debt crisis, The Washington Post, May 9, 2010.)
Dr. Gao: Greece officially defaulted on its debt to the IMF on June 30, 2015 after the government failed to make a scheduled payment, triggering a 30-day grace period and becoming the first developed country to default on its debt in many years. As you wrote in your 2010 op-ed in The Washington Post, "Who would have listened 12 months ago to someone asserting that an E.U. member would teeter on default?"
But it also needs to be noted that before 2007, financial crises were not supposed to happen in the United States or in the advanced economies.
Professor Reinhart: Exactly, financial crises were not supposed to happen in the United States or in advanced economies. The 2007-08 financial crisis involves esoteric instruments, unwitting regulators, and skittish investors. Yet it also followed a well-trodden path laid down by centuries of financial folly. This time is a problem of sub-prime mortgages, but this time was not different. In fact, there are stunning quantitative parallels across a number of major crisis indicators from the standard literature on international financial crises. And I'm not saying this in hindsight, we presented this at the American Economic Association meeting at the time, and it was later published in the American Economic Review.
Dr. Gao: This leads to your path-breaking book This Time Is Different. As I recall, and from reading your papers and listening to your lectures, this book was actually written years before the 2007-08 global financial crisis (GFC), right? I was wondering what motivated you to start working on this seminal book at that time.
Professor Reinhart: When I left the IMF in 2003, only a few months before Ken did, we had a small gathering in the research department and so on, and we announced that we would write a book. Now, the data-gathering process proved not easy, since compiling and assembling the data was quite an extensive undertaking. When I returned to the University of Maryland and Ken went back to Harvard, we spenta couple of years readjusting to academic life after our time in policy. Nevertheless, we continued working on the project, and many of our papers predate the book. We released several working papers; I mentioned the 2008 subprime paper, and there was another one entitled A Panoramic View of… I am afraid I cannot recall the full title.
Dr. Gao: A Panoramic View of Eight Centuries of Financial Crises.
Professor Reinhart: Exactly. And papers such as The Forgotten History of Domestic Debt, and Banking Crises: An Equal Opportunity Menace, all appeared in 2008. The phrase "an equal opportunity menace" means it affects everyone, which is the point we were trying to make: if you look at history, you cannot say every country has defaulted, although most have done so in one form or another. But virtually all countries have experienced financial crises. All of these papers were published before the book.
Dr. Gao: Yes, and that is why I am so impressed. I am amazed by the profound foresight demonstrated in your research. All of the papers you mentioned were published in early 2008, long before the collapse of Lehman Brothers. Another paper, Is the 2007 US Sub-prime Financial Crisis So Different? An International Historical Comparison, came out in May 2008. As I recall, however, you presented your landmark paper on January 6, 2008, at the American Economic Association（AEA）Annual Meeting in New Orleans, Louisiana, and it was formally published several months later. (Carmen M. Reinhart and Kenneth S. Rogoff. 2008. "Is the 2007 US Sub-prime Financial Crisis So Different? An International Historical Comparison." American Economic Review 98 (2): 339–44.)
Professor Reinhart: Yes. The paper attracted considerable attention. But the center of the paper was that the symptoms and patterns ofboom and bust in the US property market resembled those of other systemic crises in the postwar era. At the time, we identified only five postwar systemic crises that we used as a benchmark for the 2007 US subprime crisis: Japan in 1992, Spain in 1977, and the three Nordic crises in Norway, Sweden and Finland in the late 1980s and early 1990s. As those crises were providing a benchmark, the other factor that really caught attention was our early warning of financial crisis risk. And the Fed took note. If you look at the minutes of the FOMC conference in January 2008, you will find that they cited and discussed my paper.
Dr. Gao: Exactly, that was a Federal Open Market Committee conference call held on January 21, 2008, not a regularly scheduled meeting. As then-Fed Chair Ben Bernanke noted during the call, he was reluctant to convene the meeting, but because global stock markets had declined sharply over the previous several days, he viewed this as a symptom of both sharply mounting concerns about the economy and deteriorating conditions in credit markets. During his remarks, he specifically cited your paper. According to the meeting minutes, below is a quote from him: "It is just one indicator, but a paper by Carmen Reinhart and Kenneth S. Rogoff has been circulated in the past couple of days, which compares some indicators of our economy with other major financial crises and finds that we rank at the moment among the five largest financial crises in any industrial country since World War II. Given what their indicators show, they conclude that, if we have only a mild recession in the United States, it would be a very fortunate outcome."
Professor Reinhart: Yes, and Bernanke was at the Fed. I was also often working on the book in the Fed library, and he would visit me there from time to time. The librarians were delighted because hardly anyone ever came to the library, and I would spend a lot of time theregathering data.
Dr. Gao: Fascinating. Was that in 2007, or earlier?
Professor Reinhart: In 2006 and 2007.
Dr. Gao: Fascinating. As mentioned above, the Fed discussed your subprime paper at its January 2008 FOMC conference. From the subsequently released minutes, it appears that then-Fed Chair Ben Bernanke largely agreed with your assessment of the crisis. Yet two weeks before that Fed conference, when you presented the same paper at the AEA Annual Meeting, you actually encountered considerable pushback, because very few economists at that time foresaw just how severe the crisis would become as it later unfolded. After all, your predictions proved correct.
Professor Reinhart: Events took care of everything else. I remember Ken and I saying at the time: "we're going to look like idiots if nothing happens." But the patterns were very similar, and much of the work I have done over the course of my career is based on trying to identify these common patterns.
Dr. Gao: You were incredibly courageous at that time.
Professor Reinhart: Yes, with hindsight, yes.
Discussion 3
The amazing ability to coin memorable phrases
Dr. Gao: Back in 2021, you gave the annual Albert H. Gordon Lecture at the Harvard Kennedy School Forum, which was moderated by Professor Jeff Frankel.
Professor Reinhart: Yes, I remember. I was on leave from the Harvard Kennedy School while serving as Senior Vice President and Chief Economist of the World Bank.
Dr. Gao: Jeff has been one of my favorite professors at Harvard, and I attended many of his seminars and courses. The day after moderating your lecture, he wrote a blog post marveling at your research achievements, especially your amazing ability to coin new phrases. Here I am quoting what he wrote: "I was the moderator. In preparing my questions for her, I was struck by how many memorable phrases Carmen has coined in her research career. Here is a list of five such phrases. Three of them have their own Wikipedia entries, which is remarkable. And that doesn't even count publications of hers that also have entries." The phrases he mentioned include This Time Is Different, the title of your best-selling book with Kenneth S. Rogoff, published at the height of the 2007-09 recession and GFC. Twin Crises, the title of a paper co-authored with Graciela Kaminsky, referring to the phenomenon in which banking crises coincide with balance-of-payments crises. Debt Intolerance, the title of another paper with Ken Rogoff, which suggested that financial markets do not tolerate debt levels in EMEs as high as those they accept in advanced economies. Fear of Floating, the title of a 2002 paper with Guillermo Calvo, concerning exchange rate practices: EMs couldn't bring themselves to float their currencies freely, even those that claimed they did. Financial Repression, a phrase originally coined in 1973 by Ron McKinnon, to describe a development strategy in which developing-country governments directed banks to provide cheap loans. In 2011, you and M. Belen Sbrancia repurposed the term "financial repression" to describe policies that the US and other advanced countries pursued in the aftermath of World War II: keeping interest rates artificially low to gradually reduce national debt/GDP ratios. The implication is that Europe and the US may be employing similar policies again today. Of course, there are some other phrases Jeff didn't mention, including "fear of floating" and "serial default", I guess.
Professor Reinhart:And my latest one is "fear of hiking".
Dr. Gao: Yes, exactly.
Professor Reinhart: What motivated that was Japan. As all central banks tightened in response to the inflation spike, fear of hiking became very clear. During the European Debt Crisis, the Bank of Japan dealt with potential financial fragility by transferring sovereign risk from banks to its balance sheet. Even so, Japan's financial institutions have the largest exposure to government debt among advanced economies. Hence, its fear of hiking is not just about the government's interest expenses but also about the banks' potential capital losses. When the balance sheets of domestic financial institutions are overweight in long-term government securities, the capital losses of a rate hike are large and immediate. In Japan's case, this affects both private financial institutions and the central bank.
Dr. Gao: This is a highly important topic, and we will return to it in greater detail later.
Discussion 4
Financial repression: the fiscal and monetary policy nexus under high government debt
Dr. Gao: High public debt has been a major issue in recent years. Beyond discussions of global trade and supply chain disruptions, much of the dialogue at IMF, World Bank, and BIS meetings centers on debt-related challenges. Many advanced economies (AEs) and emerging market and developing economies (EMDEs) face severe debt vulnerabilities. According to IMF's recent Fiscal Monitor report, global public debt could reach 100 percent of global GDP by the end of the decade if current trends persist. The rising public debt-to-GDP ratio reflects renewed economic pressures as well as the legacy of pandemic-related fiscal support. This trend raises fresh concerns about long-term fiscal sustainability, as many countries confront mounting budgetary challenges. However, the question of how to reduce high debt has long been a particularly thorny issue.
Professor Reinhart: High public debt is prevalent but not universal. Australia, Denmark, Germany, the Netherlands, Norway, Sweden, Switzerland, and a few others are not facing the challenge of persistently high or rapidly rising public debt. Heterogeneity is even greater among EMDEs. Unlike the early 1980s, when large upper-middle-income EMs went into default alongside their lower income counterparts, more recent defaults, such as Ethiopia, Ghana, Niger, and Sri Lanka, among others, or near defaults, such as Egypt and Pakistan have occurred in lower-middle-income or low-income countries. These countries are not "systemic."
Debt issues are poised to worsen. In Europe, Canada and the US, larger defense outlays are probable. In addition, expenditures on climate-related needs will also expand budgets. Debt reversals