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review of: This Time Is Different: Eight Centuries of Financial Folly

"Building on a historical narrative that uses an extensive data set of their construction, Reinhart and Rogoff (hereafter R&R) show that periods of excessive public debt accumulation generally do not end well. Over time, many countries have defaulted on their debt (including restructuring) for a variety of reasons and by a variety of methods (inflating away the real value of the debt has been very popular). These defaults, they show, can produce detrimental spillover effects. Recent defaults by Russia (1998) and Argentina (2001) come to mind, and the possibility of a future restructuring by Greece looms large for its foreign creditors (for example, European banks)—and for European policymakers. One drawback of R&R’s analysis, which they readily admit, is that it focuses almost entirely on debt issued by governments, or sovereigns, rather than by the private sector. In the financial crisis of 2007-09, which they term the “Second Great Contraction,” the accumulation of private debt (chiefly mortgage debt of the dodgy variety) and the collapse in nominal house prices eventually helped trigger a banking and financial crisis of immense proportions and a collapse in economic activity. In response, federal government outlays in the United States and other advanced economies rose enormously, which resulted in huge budget deficits that have significantly boosted debt-to-GDP levels. Since emerging and developing countries tend to rely heavily on foreign creditors such as large multinational banks, sharply higher debt-to-GDP ratios in the context of weakening economic fundamentals can lead to “sudden stops”—that is, credit is withdrawn abruptly, leading to a cascade of defaults. In advanced economies, which have better credit and inflation histories, and thus sharply lower probabilities of default, rising debt-to-GDP ratios tend to weaken economic growth."