Debt issue to be chronic challenge for advanced economies: expert

10:23, April 25, 2011      

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The fiscal and debt problems that overhang global economy will be a chronic challenge for advanced economies, said a renowned U.S. expert on fiscal, debt and financial crisis studies.

"Credit cycles don't build overnight," Carmen M. Reinhart, senior fellow at the Washington-based think tank Peterson Institute for International Economics, told Xinhua in a recent interview. "We really need to get serious about debt and deficit reduction."

Reinhart, previously professor of economics and director of the Center for International Economics at the University of Maryland, divided indebted advanced economies into three groups.

The first group had a fiscal problem, meaning they had a lot of public debt to begin with and the economic downturn after the financial crisis made it worse. Greece is an example. The country already had fiscal problem, and high level of public debt, thus becoming the most susceptible to the financial crisis.

The second group of countries did not start out with a fiscal problem, but had a lot of private debt, that would be the cases of Iceland, Ireland and Spain. Those countries' pre-crisis fiscal positions were relatively balanced but their private debts became public debts after governments came to bailout troubled banks during the financial crisis.

The third one is more of the Portugal scenario, in which both problems exist. In these countries, public balance sheet already was not good, and also had a surge of private debt before the financial crisis. It is "a combination of problematic public finance situation and the post-crisis private debt builder," she said.

"For those three reasons, the advance economies now have the level of debt that we haven't seen since the end of World War II," said Reinhart, co-author of a recent best-selling book entitled "This Time is Different: Eight Centuries of Financial Folly," which documents the striking similarities of the recurring booms and busts that have characterized financial history.

Reinhart said there are three layers of government debts, namely federal government debt, plus state and local government, then plus government sponsored enterprises which include mortgage giants Fannie Mae and Freddie Mac.

The first layer of U.S. public debt, which tracks the federal government net debt to GDP ratio, is now at 94 percent, which is not yet hit the post-war high in 1946. However, the total public debt of three layers to GDP ratio is 124 percent, and that is an all time high.

The United States has the largest debt in the Organization of Economic Cooperation and Development (OECD) by a large margin, Reinhart said.

"You look at all the advanced economies, and the U.S. deficit at present, is at the extreme end of that spectrum," she said.

Commenting on the recent news that rating agency Standard & Poor downgraded the credit outlook of the United States, the former chief economist at the investment bank Bear Stearns and senior official of the IMF said that the agency "had very reasonable arguments in the negative outlook."

"It's not surprising to see that they've taken this step," said Reinhart, whose work is to help inform the understanding of financial crises for over a decade.

She said the United States has "a very difficult political environment in which debt reduction and deficit reduction are complicated."

Unlike Japan, the country depended a lot on foreign financing and the private sector balance sheet in the financial industry is still somewhat shaky that the government may still have some contingent liability in the financial industry, Reinhart added.

As for solutions to address the debt challenge, Reinhart said in the more extreme cases, including Greece, Ireland and Portugal, restructuring will be needed in addition to fiscal adjustment.

For others, including the United States, they need a combination of fiscal adjustment. All the advanced economies should do more macro-prudential regulation or "financial repression," a term widely quoted in development economics, meaning more control and regulation on financial markets.

"I don't do forecast," but from the historical perspective, "it will take a long time," she added.

Source: Xinhua
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