The inane drivel produced by the Harvard economics department.

Kenneth Rogoff and Carmen Reinhart, professors of economics at Harvard, have published dozens of papers and articles promoting the idea that if national debts grow too large, a heavy price has to be paid to reduce them. Other “economists” at Harvard have produced similar nonsense.

R&R’s basic reason is that cutting the debt probably requires what they call “financial repression” – a term Rogoff invented. Indeed he has introduced other emotive terms into this argument like “debt overhang” in place of the single word “debt” (which would do perfectly well). The reason for employing emotion may be that R&R’s command of logic and the facts is not too good, as indeed I show below. 

Or perhaps they are just a good propagandists, and have realised that very few people (academics included) are swayed by logic or facts, whereas if you can wield emotion in the right way, then you’ll have about 90% of your audience by “you know which part of the male anatomy”.

Anyway, R&R us a definition of financial repression (FR) at the bottom of p.8 of NBER working paper No. 18015. The paper is entitled “Debt Overhangs: Past and Present.” The definition, which I’ve put in green italics runs as follows.

Financial repression includes directed lending to the government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy “moral suasion”. It is often associated with relatively high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold purchases (as in the US from 1933 to 1974), or the placement of significant amounts of government debt that is nonmarketable.
 
So in general terms, FR consists of one or more damaging / distortionary measures the aim of which is to cut government debt or make it easier for government to deal with its debt.

There is of course another and very obvious damaging way of cutting the debt, namely a period of excess inflation. And R&R (several times) mention inflation as a way of cutting the debt (in real terms). But curiously, they do not classify excess inflation as a form of FR. I don’t regard that as a very logical classification, but never mind: I’ll stick with it in the paragraphs below.

 
R&R’s central claim is complete nonsense.
 
So the central claim is that governments are forced to employ damaging strategies to cut their debts. That claim is actually nonsense: that is, it is very easy for a country which issues its own currency to cut its debt. All it has to do is print money, buy back the debt and as to any excessive inflationary effects of that money printing, that can be dealt with simply by raising taxes and/or cutting public spending.

And what do you know? We’ve been doing just that, and big time, over the last five years or so under the guise of quantitative easing (QE)! And where are the serious inflationary effects of QE? They’re nowhere to be seen!!! You really have to wonder whether Harvard economists have heard of QE, don’t you?

So while some sort of tax increase is probably needed to counter the inflationary effects of buying back debt, it looks like the actual amount of extra tax needed is not much.

Now the economically illiterate (e.g. Harvard “economists”) could respond to that by claiming that more tax equals a cost just like the other undesirable elements making up FR or excess inflation. But note that the SOLE EFFECT of those raised taxes is to keep demand at its full employment level: i.e. stop demand rising ABOVE that level.

Thus demand and GDP are not affected!! So where is the REAL COST associated with the latter method of cutting the debt? It doesn’t exist: at least it does not exist in the “real standards of living decline” sense.

Or to be more accurate, there DOESN’T NEED to be any effect from that tax increase other than to keep inflation under control. In contrast, when raising taxes, government MAY CHOOSE to impose some sort of distortionary tax, but to repeat, there is no need for any distortion.

Moreover, there’d be no big difficulty in using the above strategy to cut the debt to zero: or put another way, as advocates of Modern Monetary Theory (MMTers) keep pointing out, the government of a country which issues its own currency has complete control over the rate of interest it pays on its debt.


Debt held by foreigners.
 
The only exception to the above argument to the effect that cutting the debt is costless comes with debt held by foreigners, or more accurately, by internationally mobile investor / savers. That is, some of the internationally mobile, when they find they get no interest from the US government for example, may choose to invest their money in some other country – or they may invest their money elsewhere in the US.

But if they take their money out of the country, i.e. convert their US dollars to another currency, that means a temporary decline in the dollar on foreign exchange markets, which means a temporary cut in living standards for US citizens.

The effect there is essentially the same as a household which borrows from some entity outside the household, e.g. a bank – let’s say to buy a new car. The initial effect of the loan is to raise the household’s standard of living: it has a new car to drive around in. But the day of reckoning has to come at some point: the household has to work extra hours to earn the money to pay back the loan.

The latter fall in the household’s standard of living approximately equals the earlier rise due to being able to driver around in a new car.

But needless to say, R&R do not deal with the latter distinction  between debt held domestically, and debt held by foreigners or the internationally mobile. 


Any costs involved in repaying debt result from paying interest on the debt.
 
A final point here is that the latter foreign exchange related costs involved in repaying the debt would largely vanish if (as suggested by MMT) little or no interest is paid on the debt.

In other words if a government offers no reward to those holding its currency, then in the event of its raising taxes and cutting the amount of that currency in private sector hands, there is no reason for foreigners to hold any less of the currency, because the interest earned on their currency holding is at or near zero before and after the latter tax is imposed!