A recent article in the American Economic Journal: Macroeconomics by Suffi and Trebbi called "Resolving Debt Overhang" discusses the impact of debt overhang after a crisis. Their argument and data suggests that politics get polarized and fractured, so that there is little that will be done in the way debt reform. The size of the governing coalition shrinks and the new government post-crisis will be more fragmented. "Vote the bums out of office", but voters then cannot agree on what should be done next. There is more polarization given increases in income inequality, differences between debtors and creditors, and a general divisiveness across the electorate. The result is weak leadership when more leadership may be needed.
Sounds just like the US over the last five years; however, they do not argue from the specific case of the US but shows how this is something that has occurred throughout history after crises. The government may not be able to form a mechanism for solving debt overhang issues. This means that after-effects from a crisis will last longer than a more modest shock. We could face slow growth for an extended period because debt restructuring cannot be solved and changes in fiscal policy may not be approved.
Is there a solution? None are immediately apparent in a democracy. We can only observe and act on what history is telling us.
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