Monday, February 25, 2013
Vulnerable to an Adverse Feedback Loop
There is a new paper that studies the issues for countries with high debt loads and the math of how this makes countries "vulnerable to an adverse feedback loop" when debt gets over 80% of GNP. It is an academic paper and does have a bunch of math, so not for everyone, but I think it is a very good paper.
Krugman thinks the paper should have made a bigger distinction between countries that print their own money and those that don't. I think the paper well understands that some countries print money.
Abstract from the paper:
Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80% of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course. A potential fiscal crunch also puts fundamental limits on what monetary policy is able to achieve. In simulations of the Federal Reserve’s balance sheet, we find that under our baseline assumptions, in 2017-18 the Fed will be running sizable income losses on its portfolio net of operating and other expenses and therefore for a time will be unable to make remittances to the U.S. Treasury. Under alternative scenarios that allow for an emergence of fiscal concerns, the Fed’s net losses would be more substantial.