Reducing Debt Via A Modern Debt Jubilee

The world is drowning in debt, and the situation is only getting worse - especially after COVID. All types of debt - government, household and corporate - have been rising, relative to GDP, in almost all countries.


Debt in the USA is the highest it has ever been - see Figure 1.

Figure 1: USA Debt since the 1830s

Figure 2 shows a representative sample of major economies since WWII. Australia is the worst on household debt, France on corporate debt, and Japan on both government and total debt. Almost all countries have experienced rising total debt since WWII.

Figure 2: Debt levels for selected economies (BIS Data)

All schools of economic thought think a high level of debt is a problem - they just differ on what sort of debt they worry about.

Neoclassical (and "Austrian") economists worry about government debt. They claim that government debt "crowds out" private sector investment, by borrowing money that the private sector could have used to invest, and that it saddles future generations with the burden of paying back that debt (Mankiw 2016, pp. 556-57). They don't worry about private debt, because they see changes in the level of private as simply a transfer of spending power from one private individual to another, and they claim that, unless there are huge differences in their tendency to spend money, the effect on the macro economy should be slight (Bernanke 2000, p. 24).

Post-Keynesian (and "MMT") economists worry about private debt. They claim that bank lending creates money, and this adds to demand, directly affecting the macro economy. Financial crises are caused by too high a level of private debt, followed by credit - the change in debt - turning negative (Keen 2020). They don't worry about government debt, because they point out that the government "owns its own bank", and can create the money needed to pay interest on its debt, so long as it is denominated in its own currency (Kelton 2020).

In 2014, The Bank of England came down on the side of the Post Keynesians in this dispute (McLeay et al. 2014): contrary to what economic textbooks argue, bank lending creates money. This new money is borrowed in order to be spent, so that new private debt adds to aggregate demand, driving both GDP (see Figure 3) and asset prices (see Figure 4 and Figure 5). The primary explanation for the savage decline in the Spanish economy from 2008 till 2014 was the plunge in credit - the change in private debt - from plus 35% of GDP in 2008 to minus 20% in 2014.

Figure 3: Credit and Unemployment in Spain

The boom, bust and recovery of American house prices between 1997 and now was driven by changes in the level of household credit - see Figure 4.

Figure 4: USA Household Credit and House Prices

Though the underlying factor in the stock market boom since 2009 has been Quantitative Easing, changes in margin debt have driven the ups and downs of the market - see Figure 5.

Figure 5: USA Margin Credit and Share Prices

Our post-Global-Financial-Crisis world is thus characterized by excessive private sector debt and a moribund private sector, with economic performance kept afloat predominantly by government schemes (like Quantitative Easing) and large budget deficits that in turn lead to high levels of government debt. To escape from this impasse, we need to reduce private debt relative to GDP - and preferably without also further increasing the government debt to GDP ratio.

Conventional ideas about how to reduce the level of debt compared to GDP boil down to three solutions: to simply pay the debt down, to grow GDP faster than debt, or to "inflate our way out of debt". However, the empirical record implies that none of these methods will work.

Irving Fisher, who developed the "Debt-Deflation Theory of Great Depressions" pointed out that the "pay it down" route fails because reducing debt directly also destroys money dollar for dollar: just as a new loan increases the money supply, paying debt down reduces it:

A man-to-man debt may be paid without affecting the volume of outstanding currency, for whatever currency is paid by one ... is received by the other, and is still outstanding. But when a debt to a commercial bank is paid by check out of a deposit balances that amount of deposit currency simply disappears. (Fisher 1932, p. 15)

The fall in money can cause a greater fall in GDP, thus resulting in a rising debt to GDP ratio from direct repayment of debt - a phenomenon that I call "Fisher's Paradox":

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