Reducing Debt Via A Modern Debt Jubilee

the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. (Fisher 1933, p. 334)

Philanthropist and ex-banker Richard Vague reports in his recent book A Brief History of Doom (Vague 2019) that growing out of debt only worked for economies experiencing sudden, huge export booms, while inflation has never reduced debt significantly.

The only way that debt was reduced, he found, was by writing it off: debt cancellations of one form or another were the only way that countries had reduced their debt burdens substantially.

A debt-cancellation obviously benefits debtors, but it could force creditors - specifically, banks - into bankruptcy. It also rewards those who borrowed to speculate on rising house and share prices, but does nothing for those who weren't party to the gambling. We need a way to reduce debt relative to GDP, without tanking the economy, without creating moral hazard by letting debtors off the hook while bankrupting creditors, and without rewarding those who rode the debt bubble over those who didn't, wouldn't, or couldn't speculate with borrowed money. And, preferably, without causing a Great Depression and a World War, events that accompanied the last major reduction in debt levels between 1932 and 1953 - see Figure 1 and Figure 11.

A "Modern Debt Jubilee" could achieve this. A Modern Debt Jubilee uses the capacity of the government to create money to reduce private debt by effectively swapping credit-backed money for fiat-backed money:

  • Rather than debtors having their debt reduced, everyone - borrower or saver - is given the same amount of government-created money;
  • Debtors must reduce their debt; savers get cash that must be used to buy newly-issued corporate shares;
  • The proceeds from selling these shares must be used to pay down corporate debt; and
  • The Jubilee gives banks the finances needed to buy Jubilee Bonds, the interest income from which compensates them for the fall in their income from private debt.

This paper models a Modern Debt Jubilee using Minsky, an Open Source (i.e., free) system dynamics program. Minsky's unique feature, called a "Godley Table", is a double-entry bookkeeping table that makes it much easier to model financial dynamics than it is in standard system dynamics programs (to run the attached model, download the latest version of Minsky here).

The key outcomes of the model are:

  • The Jubilee reduces overall debt levels, relative to GDP;The private debt to GDP ratio falls immediately because of the Jubilee;

    Government debt rises as much as private debt falls, but the government debt to GDP ratio rises less because of the stimulatory effects of the Jubilee on GDP;

    The total debt to GDP ratio therefore falls immediately as a result of the Jubilee; and

  • Over time, the Jubilee stimulates the economy because the fall in indebtedness boosts aggregate demand, by transferring money from those who spend slowly (primarily bankers) to those who spend quickly (workers).

A policy which requires an initial increase in government debt - as fiat-created money replaces credit-based money - thus ends up reducing both government and private debt relative to GDP - see Figure 6.

Figure 6: A Modern Debt Jubilee reduces both private and government debt ratios

How does this magic happen? The basic mechanism is that the Modern Debt Jubilee (MDJ) reduces the inequality that rising level of private debt have caused.

A higher level of private debt, even with falling interest rates, results in a larger fraction of the economy's money residing in the financial sector rather than the real economy - the shops and factories where physical output are produced, and profits and wages are actually generated. The Modern Debt Jubilee reverses this: by reducing private debt levels, less debt-servicing is needed, and therefore more of the existing amount of money turns up in the hands of workers, who spend much more rapidly than do bankers. Because they spend more rapidly, that money expands activity in the firm sector, causing GDP to rise. The increase in what mainstream economists call the "velocity of money" (see Figure 7) generates more GDP from the same amount of money, and debt to GDP ratios fall over time.

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