‘A Period of Subpar Growth’
Economist Carmen Reinhart discusses government debt, lessons from Japan, and more.


For anyone eager to understand the history of financial meltdowns and the consequences of skyrocketing public debt, the work of economists Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard is simply invaluable. Two years ago — prior to the Bear Stearns bailout, at a time when the U.S. unemployment rate was hovering around 5 percent — their paper on the origins of banking crises across the developed world made a splash at the American Economic Association’s annual meeting in New Orleans. A year later, Reinhart and Rogoff unveiled a new paper on the aftermath of financial implosions in both rich and poor countries. They expanded on these topics in their widely discussed 2009 book, This Time Is Different: Eight Centuries of Financial Folly. More recently, they made headlines with a study of how government debt can hamper economic growth.

Like their earlier research, the debt study is both timely and unnerving, given the ongoing turmoil in Greece, the related troubles in other Eurozone states (Ireland, Italy, Portugal, Spain), and the deteriorating fiscal position of the United States. Reinhart and Rogoff conclude that when public debt surpasses 90 percent of GDP, it is “associated with notably lower growth outcomes.” President Obama’s 2011 budget blueprint projects that the ratio of publicly held federal debt to GDP will reach 77 percent in 2020, up from about 64 percent today. But as the Financial Times reported in early February, Moody’s Investors Service has estimated that when state- and local-government debt is included, America’s overall public-debt-to-GDP ratio could be “well over 100 percent in 2020.”

The U.S. debt surge is partly a result of extraordinary pump-priming measures. But a severe financial crisis will always lead to a ballooning debt, Reinhart tells me. Indeed, even absent the $700 billion Troubled Asset Relief Program (TARP) and the $787 billion economic-stimulus package, America’s debt load would have jumped significantly. Reinhart and Rogoff calculate that during the three years after the typical systemic banking crisis, real public debt increases by an average of roughly 86 percent, largely due to plummeting tax revenues and the effects of countercyclical fiscal policy.

While Reinhart accepts that major financial shocks inevitably produce soaring debt, she is not sanguine about the consequences. America’s massive debt overhang is harming economic growth, she says, and Washington urgently needs to devise a fiscal “exit strategy.” Reinhart fears it could take “a very rude wakeup call” to catalyze the necessary reforms. She points to Canada’s experience during the mid-1990s. At the time, our northern neighbor was carrying an unsustainable debt burden. Then Mexico’s peso crisis erupted, and its sovereign spreads began acting like those of an emerging-market country. This spurred Canadian lawmakers to tackle their borrowing problem.