The Durable Hibernating Of Vigilantism

When their paper came out in January 2010, Carmen Reinhart and Kenneth Rogoff put a number on bond vigilantism as it had been known in prior history. The idea behind investor fickleness was simple and intuitive: profligate governments who finance their ill spending ways by borrowing will literally end up paying the price once the exceed common sense. And when those governments do, the people they claim to represent are those who really end up footing the bill.

The uncontroversial history behind the process is one key reason why this becomes such an emotional topic; the stakes are enormous and, like it or not, they will affect everyone underneath any regime running afoul.

What Reinhart and Rogoff had found was the number 90 (for both advanced and emerging market countries). In other words, when anyone’s central government debt (public) reached 90% of real GDP, this appeared to have triggered vigilantism before then a slew of negative consequences.

Among them, a statistically significant drop off in economic growth and the rate of advance for living standards. It’s that last part which really impacts the average person on the street, and by which the average person actually judges the overall situation and their place in it. Maybe not consciously, but as a group we absolutely “feel” when the rate of change has changed for the worse, and remains worse for a prolonged period of time.

First the statistics behind all this:

[T]he relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.

While no definitive explanation is offered, theories connect higher debts with eventually higher taxes and/or spending cuts which, in the authors’ view, is a drag upon aggregate demand (neo-Keynesian framework).

In such a case, then, the number ninety holds special significance for that being the most likely point when vigilantism might be unleashed.

Why are there thresholds in debt, and why 90 percent? This is an important question that merits further research, but we would speculate that the phenomenon is closely linked to logic underlying our earlier analysis of “debt intolerance” in Reinhart, Rogoff, and Savastano (2003). As we argued in that paper, debt thresholds are importantly country-specific and as such the four broad debt groupings presented here merit further sensitivity analysis. A general result of our “debt intolerance” analysis, however, highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and thereby reduce risk premia.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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