Stiglitz heymann (eds ) life after debt; the origins and resolutions of debt crises (2014)

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Other titles from IEA:
LIFE AFTER DEBT
The Origins and Resolutions of Debt Crisis
Edited by Joseph E. Stiglitz and Daniel Heymann
INCOME CONTINGENT LOANS
Theory, Practice and Prospects
Edited by Joseph E. Stiglitz, Bruce Chapman and Timothy Higgins
TAMING CAPITAL FLOWS
Capital Account Management in an Era of Globalization
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The Role of Government Beyond Ideology
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A New Transition
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IS ECONOMIC GROWTH SUSTAINABLE?
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POST-CONFLICT ECONOMIES IN AFRICA
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STRUCTURAL REFORM AND MACROECONOMIC POLICY
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THE PAST, PRESENT AND FUTURE OF THE EUROPEAN UNION
Edited by Alan V. Deardorff
LATIN AMERICAN ECONOMIC CRISES
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Edited by Enrique Bour, Daniel Heymann and Fernando Navajas
ADVANCES IN MACROECONOMIC THEORY
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EXPLAINING GROWTH
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Life After Debt
The Origins and Resolutions of Debt Crisis
Edited by

Joseph E. Stiglitz
University Professor, Columbia University, USA
and

Daniel Heymann
Professor of Economics, University of Buenos Aires, Argentina


© International Economic Association 2014
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Contents
List of Figures

vii

List of Tables

viii

Foreword and Acknowledgements

ix

Notes on the Contributors

xii

Introduction
Joseph E. Stiglitz and Daniel Heymann

1

Part I Analytical Issues
1.1 Crises: Principles and Policies
Joseph E. Stiglitz
1.2 Comment on “Crises: Principles and Policies” by Joseph E.
Stiglitz
Martin Guzman

43

80

Part II Debt Crises: Varieties of Experiences
2.1 The Latin American Debt Crisis in Historical Perspective
José Antonio Ocampo
2.2 Comment on “The Latin American Debt Crisis in Historical
Perspective” by José Antonio Ocampo
Pablo Sanguinetti
2.3 What Have the Crises in Emerging Markets and the Euro Zone
in Common and What Differentiates Them?
Roberto Frenkel
2.4 Comment on “What Have the Crises in Emerging Markets
and the Euro Zone in Common and What Differentiates Them?”
by Roberto Frenkel
Ricardo Bebczuk

2.5 From Austerity to Growth in Europe: Some Lessons from
Latin America
Stephany Griffith-Jones
2.6 Comment on “From Austerity to Growth in Europe:
Some Lessons from Latin America” by Stephany Griffith-Jones
Hernán D. Seoane
v

87

116

122

142

145

171


vi

Contents

Part III Debt Defaults: Costs and Restructuring Games
3.1 Strategic Behavior in Sovereign Debt Restructuring:
Impact and Policy Responses’
Rohan Pitchford and Mark L.J. Wright
3.2 Comment on “Strategic Behavior in Sovereign Debt

Restructuring: Impact and Policy Responses” by Rohan
Pitchford and Mark L.J. Wright
Federico Weinschelbaum
3.3 “Sovereign Debt Restructuring: The Road Ahead”
Benu Schneider
3.4 Commentary on “Sovereign Debt Restructuring: the Road
Ahead” by Benu Schneider
Fernando Navajas

179

191
193

221

Part IV Dealing with Crises: Instruments and Policies
4.1 Saving the Euro: Self-fulfilling Crisis and the “Draghi Put”
Marcus Miller and Lei Zhang
4.2 Comments on “Saving the Euro: Self-fulfilling Crisis and
the ‘Draghi Put’ ” by Marcus Miller and Lei Zhang
Alfredo Schclarek Curutchet
4.3 “GDP-linked Bonds and Sovereign Default”
David Barr, Oliver Bush and Alex Pienkowski
4.4 Comment on “GDP-Linked Bonds and Sovereign Default”
by David Barr, Oliver Bush and Alex Pienkowski
Enrique Kawamura
4.5 “Multiple Choices: Economic Policies in Crisis”
Daniel Heymann and Axel Leijonhufvud
4.6 Comment on “Multiple Choices: Economic Policies in Crisis”

by Daniel Heymann and Axel Leijonhufvud
Jorge Carrera
Index

227

242
246

276
281

309

317


List of Figures
2.1.1 Economic crises of Latin America 1820–2008: A. Number of
countries on a currency, external debt, or banking crisis; B.
Number of country/years in crisis by period
2.1.2 Economic growth and trade balance
2.1.3 Net resource transfer (% of GDP at current prices)
2.1.4 A. Real interest rates; B. Real non-oil commodity prices (1980=100)
2.1.5 Dynamics of the Latin American external debt
(% of GDP and exports)
2.1.6 A Comparison between the crises of the 1930s and 1980s:
external indicators: A. Purchasing power of exports; B. Trade
Balance as % of exports (vs 1929 and 1980)
2.1.7 A comparison between the crises of the 1930s and 1980s:

GDP and per capita GDP: A. GPD; B. Per capita
2.1.8 Public sector finances and inflation (simple averages), A. Central
government deficit; B. Median rate of inflation
2.5.1 Additional proposed EIB and EU growth expenditure program
(billions of Euros)
2.5.2 Estimates of the European GPD growth with and without
investments pact
2.6.1 GDP volatility, selected Latin American countries
2.6.2 GDP volatility, selected European countries
4.1.1 Spreads and debt to GDP ratio in the Euro Zone (2001Q1–2011Q3)
4.1.2 Spreads and debt to GDP ratio in stand-alone countries
(2000Q1–2011Q3)
4.1.3 Self-fulfilling partial default
4.1.4 Avoiding the default equilibrium with the Draghi Put
4.1.5 Effects of OMT
4.1.6 BEFORE: investors holds sovereign bonds – but are
prone to switch
4.1.7 AFTER: stability and growth fund pools sovereign debt – and
diversifies types of bond
4.3.1 Debt dynamic phase diagram
4.3.2 Real GDP growth outturns, 1870–2008
4.3.3 Expected return on conventional and GDP-linked bonds
4.3.4 Output growth and the change in the primary balance,
conventional bonds
4.3.5 Output growth and the change in the primary balance,
GDP bonds
vii

89
92

95
97
99

101
107
109
155
158
174
175
231
231
234
236
236
238
239
258
258
263
267
267


List of Tables
2.1.1
2.5.1

Gross Fixed Capital Formation (% of GDP)

Original Brady/exchange issue amounts (US$ bn) and
multilateral debt relief agreements with commercial banks
2.5.2
Additional proposed EIB and EU growth expenditure
programme (in € billions)
2.5.3
Effect of Investment Pact on GDP and employment
2.5.4
GDP in £ billion, 2010 prices under two scenarios
4.1.1
The debtors’ dilemma: An engine of austerity?
4.1.2
Different types of stability bonds
4.1.3
Balance sheet of SPV
4.3.1
Model calibration
4.3.2
Sensitivity of parameter values
4.3.3
Debt limits under various coefficients of relative risk aversion
4.3.A1 Summary of key model outputs

viii

93
149
155
159
166

237
238
239
255
257
262
272


Foreword and Acknowledgements
This volume collects papers and comments presented in the Roundtable on Debt
Crises and their Resolution organized in Buenos Aires, Argentina, in August
2012 by the International Economic Association (IEA) jointly with the Argentine
Association of Political Economy (AAEP) and the Faculty of Economic Sciences of
the University of Buenos Aires (FCE- UBA), with the sponsorship of the Argentine
Ministry of the Economy, the Institute for the Integration of Latin America and
the Caribbean (INTAL , IDB) and the National University of Córdoba (UNC).
The project of the conference derived from the recognition that debt crises
continue to pose substantial analytical challenges, and that a discussion of the
topic would be particularly pertinent at the time and place of the meeting. The
financial turbulences and macroeconomic contractions of central economies
in recent years have shown that high wealth and state-of-the-art institutions
do not provide immunity against debt-originated disturbances. Europe, in particular, is still dealing with difficultywith the crises in its periphery, which have
proven to be highly costly, not only in terms of economics, but also in terms
of the broader burdens placed on society; and it has yet to find ways to restore
growth in the region as a whole. Latin America, for its part, has a long history of
crises and more or less strong recoveries, which offer a rich experience on which
to contrast analytical propositions about the prevention, causes, and resolution
of debt crises anddiscuss policy proposals, with due regard for the specificities of each episode. Argentina, in particular, offers an example of one of the
themes of the conference: overcoming a crisis may be helped considerably, in

some cases, by a restructuring of financial contracts aimed towards the sustainability of future obligations when the volume of outstanding debts has become
excessive. Argentina managed its way through a very deep crisis, using as part
of its set of instruments a large-scale redefinition of debt obligations, public and
private. After dramatic episodes, there was indeed life after debt; at the same
time, the country´s recent economic performance hasalso shown that a lighter
debt burden, while necessary,may certainly not be sufficient to determine a
stable macroeconomic trend of solid growth. In calling for the Roundtable, we
thought it would be particularly useful to think about the European crisis, then
in its early days, from the vantage point of the lessons that might be learned
from the experiences of others, and in particular that of Argentina.
By their very nature, debt crises are systemic events, driven by intricate interactions of individual and collective behaviors. This book looks both at crises
which originate in the public sector and at those that arise from excessive
indebtedness in the private. We do this for good reason: one kind of debt crisis
ix


x Foreword and Acknowledgements

quickly morphs into the other. Sovereign debt crises typically lead to macroeconomic disturbances of sufficient depth and duration that private parties
encounter difficulties in repayment. Private debt crises often lead to high levels
of public indebtedness, both because of political pressures put on governments
to assume the private debts (as happened in both the East Asian and European
crises) and because the macroeconomic decline leads to massive shortfalls in
government revenues.
Studying such multifacetedevents under the umbrella of the “everything
else constant” assumption (and, in particular, the strict demarcation of narrowly economic, social and political phenomena) must be considered at most
as a precarious point of departure. However, a modicum of analytical precision
requires delimiting the field of vision. No collection of papers can presume to
offer a full picture. In this book we concentrate on some aspects of debt crises,
emphasizing lessons that may be drawn from international comparisons, and

the discussion of policy alternatives, especially referring to the opportunity,
procedures and outcomes of sovereign debt restructurings.
The volume is divided in four parts. In the first, Joseph Stiglitz presents an
overview of analytical issues and sets the scene by placing the theory of crises
within the context of standard economic theory. The second section of the
book includes papers by José Antonio Ocampo, Roberto Frenkel and Stephany
Griffith-Jonesthat review international experiences of macroeconomic crises,
particularly in Latin America, in order to draw analytical implications, and
relate those experiences to the current European predicament. The papers in
the third section of the book focus on sovereign debt restructurings, which
are approached from two angles. Rohan Pitchford and Mark Wright consider a
game-theoretic setup where a debtor in default negotiates with several groups
of creditors; their main interest is to explain delays in closing restructuring
agreements.Benu Schneider discusses alternative institutional setups for the
renegotiation of country debts, with reference to the debates surrounding the
proposal of the introduction of a Sovereign Debt Restructuring Mechanism
(SDRM) in the early 2000s. The fourth part of the volume contains papers
on policies and instruments to deal with crises; included in the discussion is
a theme that was featured in theprevious part: the design of debt contracts
and, specifically, the possibility of substituting formally unconditional obligations with contingent assets, such as GDP-linked bonds. This topic forms the
core of the paper by David Barr, Oliver Bush and Alex Pienkowski. Marcus
Miller and Leo Zhang deal with issues related to the Euro Zone crisis; they
discuss actions at the European levelto prevent the emergence of coordination failures in the financing of public debts and avoid costly signaling games
of governments trying to woo capital markets; they analyze the creation of
a supranational agency that would issue Eurobonds and holdsovereign debt,
including newly created state-contingent bonds The paper by Daniel Heymann


Foreword and Acknowledgements

xi

and Axel Leijonhufvud closes the volume with a discussion of various dimensions of the decision problems faced by policymakers in the development and
resolution of macroeconomic debt crises, according to the type and intensity
of the disturbance.
The Roundtable provided the framework for a rich and relevant conversation
between economists with different backgrounds and geographical origins,
joined by a common interest in understanding the complex processes of
macroeconomic crises and exploring ways to prevent them or mitigate their
social impact. We hope that the contents of the volume may convey the spirit
of that lively exchange of ideas, and contribute to the search for improvedsss
analytical approaches and for better macroeconomic policies.
The editors would like to acknowledge gratefully the contribution of the
local organizing committee of the conference, presided over by Alberto
Barbieri (Dean of the Faculty of Economic Sciences of the University of Buenos
Aires) and composed by Ernesto Rezk (National University of Córdoba,UNC,
President of the AAEP at the time), Cecilia Rumi (National University of La
Plata and AAEP), Laura D´Amato (FCE-UBA and AAEP), MónicaPanadeiros (FIEL
and AAEP), Andrés López (FCE-UBA),Adrián Ramos (FCE-UBA and AAEP), and
Roberto Pons (FCE-UBA). Cecilia Arena played an important role in coordinating the logistics of the conference. Pilar Palacios, Secretary of the IEA, participated actively and efficiently in the organization of the Roundtable and the
compilation of this book; her work was essential for carrying the project to
completion.


Notes on the Contributors

David Barr is Senior Adviser for financial stability at the Bank of England’s
Centre for Central Bank Studies. He spent the 1980s in the Bank as a bond fund
manager and adviser on mathematical finance before leaving to spend 15 years
in the university sector in the UK. His main research areas are fixed income

markets and financial contagion.
Ricardo Bebczuk is Full Professor, Universidad Nacional de La Plata, and Visiting
Professor, University of Illinois at Urbana-Champaign, where he obtained his
Ph.D. in Economics. He obtained his Master’s in Banking Disciplines from
Università di Siena-Universidad Nacional de La Plata, Argentina. His field of
expertise is macroeconomics and finance. He is the author or co-author of 12
books, published in Argentina, Spain, Mexico, the US and the UK, including
Asymmetric Information in Financial Markets: Introduction and Applications (2003)
and Para entender la economía: 12 preguntas esenciales (2012). Additionally, he
has published numerous academic and policy papers. He is a regular consultant for the International Monetary Fund, World Bank, Inter-American
Development Bank, United Nations, and various Argentine and Latin American
institutions.
Oliver Bush is an economist in the Prudential Policy Division of the Bank of
England. He works on macroprudential policy. Prior to this, he worked for the
International Finance Division at the Bank and for the CBI.
Jorge Carrera is Head of the Economic Research Department, Central Bank of
Argentina. He lectures in International Finance at the University of La Plata,
Master’s degree courses at the University of Bologna and the University of
Buenos Aires and before, he lectured at the University of Pavia, Italy. He has
written over 50 papers and seven chapters for different books. As a representative of the Central Bank of Argentina, he has conducted studies about the
redesigning of the international financial architecture and he is a technical
delegate for G-20 and FSB (Financial Stability Board). His current research work
focuses on the theoretical and empirical implications of financial and trade
internationalization for emerging economies.
Roberto Frenkel is Principal Research Associate at CEDES and Honorary
Professor at the University of Buenos Aires. Presently he is also Director of
the Graduate Program on Capital Markets (University of Buenos Aires) and
teaches graduate courses at the Di Tella and FLACSO-San Andrés Universities
in Argentina. He was Professor at the University of Chile, University Católica

xii


Notes on the Contributors

xiii

de Chile, University Central de Venezuela and also visiting professor at the
University of California (San Diego), University Católica de Rio de Janeiro and
University of Pavia (Italy). He has also taught courses and has given lectures at
other Argentine and foreign universities. He has been a consultant of several
international organizations including UN, ILO, UNCTAD, UNDP, ECLAC, and
he has also worked for the OECD Development Center, IDB, UNIDO and the
governments of Argentina, Bolivia, Colombia, Venezuela and Uruguay. He
was Undersecretary Chief of Economics Advisors to the Ministry of Finance
(1985–89) and a member of the Board of Directors of the Banco de la Provincia
de Buenos Aires (1999–2003) both in Argentina. He was a member of the
Board of the World Institute for Development Economic Research (WIDER),
United Nations University, and also a member of the UNDP Advisers Group.
He published numerous books and articles in academic journals on macroeconomic theory and policy, money and finance, inflation and stabilization policies and labor market and income distribution, with special focus on Argentina
and Latin America.
Stephany Griffith-Jones is Financial Markets Director at the Initiative for Policy
Dialogue, based at Columbia University in New York and Associate Fellow at
the Overseas Development Institute. Previously she was Professorial Fellow at
the Institute of Development Studies at Sussex University. She is an economist
specialising in international finance and development, with emphasis on
reform of the international financial system, specifically in relation to financial
regulation, global governance and international capital flows. She has acted as
senior consultant to governments in Eastern Europe and Latin America and to
many international agencies, including the World Bank, the Inter-American

Development Bank, the European Commission, UNICEF, UNDP and United
Nations Conference on Trade and Development. She has published over 20
books and written many scholarly and journalistic articles.
Martin Guzman is a Postdoctoral Research Fellow at Columbia University
Graduate School of Business, and an Assistant Professor at Universidad Nacional
de La Plata (Argentina). He received his PhD in Economics from Brown
University in 2013. Before, he had studied at Universidad Nacional de La Plata,
where he graduated as a BA and MA in Economics. His fields of research are
macroeconomics, monetary economics, and economic growth.
Daniel Heymann is Professor of Economics at the University of Buenos Aires
(UBA) and the University of San Andrés, and Director of the Interdisciplinary
Institute of Political Economy of Buenos Aires (IIEP-BAIRES), created jointly
by UBA and the Argentine National Research Council (CONICET). He studied
Economics and Physics at UBA, and received his Ph.D. in Economics from
UCLA. He is a member of the Argentine Academy of Economic Sciences, and
was President of the Argentine Economic Association (AAEP) for the term


xiv Notes on the Contributors

2008–2010. His areas of interest are macroeconomics, development, and
complex system models in economics. He has written extensively on the
macroeconomics and the political economy of extreme disturbances marked
by high inflations or debt crises, and about the interaction between growth
trends and large macroeconomic fluctuations.
Enrique Kawamura is Associate Professor at Universidad de San Andrés, in
Argentina. He specializes in macroeconomic modeling under uncertainty,
Monetary and Banking Economics, as well as bounded rationality modeling.
He has published in major journals like the Journal of Economic Theory and the
Journal of Monetary Economics. He holds a Ph.D. from Cornell University.

Axel Leijonhufvud earned a bachelor’s degree at the University of Lund,
Sweden, and his Ph.D. in Economics from Northwestern University. Between
1971 and 1994 he was Professor of Economics at the University of California, Los
Angeles, where he served on several occasions as Chairman of the Economics
Department. From 1995 he has been Professor of Monetary Theory and Policy
at the University of Trento, Italy, and became Emeritus Professor in 2009. He
received honorary degrees from the Universities of Lund, Sophia-Antipolis
(France) and Cordoba (Argentina). His abundant research has focused particularly on macroeconomic theory and the analysis of extreme macroeconomic
disturbances. His works include On Keynesian Economics and the Economics of
Keynes (translated into German, Italian, Spanish, Japanese, Serbo- Croatian
and Chinese); Information and Coordination, and High Inflation.
Marcus Miller is Professor of Economics at Warwick University, teaching international macroeconomics for masters students, and also a Research Fellow
at CEPR, London, Visiting Fellow at PIIE, Washington. Educated at Oxford
University (PPE) and Yale University (Ph.D.), his academic career includes posts
at the London School of Economics and Manchester University, with visiting
positions at Chicago University Business School and Princeton University. He
has worked as an economist and as Houblon-Norman Fellow at the Bank of
England; acted as advisor to the Treasury Committee of the House of Commons;
was Member and Chair of Academic Panel of the Treasury and joint director
of International Macroeconomics Programme at CEPR , London. Has recently
published papers on global imbalances, bank regulation and Quantitative
Easing. Current research interests include sovereign debt restructuring, fiscal
consolidation and imprisonment as a discipline device in Stalin’s Russia.
Fernando Navajas is a professor at the economics departments of the Universities of Buenos Aires and La Plata, and Chief Economist at FIEL, Argentina. He
is also Director of the Applied Economics Institute at the National Academy
of Economic Science of Argentina. He has long experience as a consultant in
Latin America for international agencies and for official and private institutions. Previously he was senior economist at the UN ECLAC. He holds a Ph.D.


Notes on the Contributors

xv

from the University of Oxford. He has published papers and chapters on many
areas of macro- and microeconomics focused mainly on Latin America and for
the IEA he co‐edited a book on the Latin American Macroeconomic Crisis, Trade
and Labor. His most recent contributions relate to several dimensions of energy
economics.
José Antonio Ocampo is Professor, Member of the Committee on Global
Thought and co-President of the Initiative for Policy Dialogue at Columbia
University. He has occupied numerous positions at the United Nations and in
his native Colombia, including UN Under-Secretary-General for Economic and
Social Affairs, Executive Secretary of the UN Economic Commission for Latin
America and the Caribbean (ECLAC), and Minister of Finance of Colombia.
He has received numerous academic distinctions, including the 2012 Jaume
Vicens Vives award of the Spanish Association of Economic History for the best
book on Spanish or Latin American economic history, the 2008 Leontief Prize
for Advancing the Frontiers of Economic Thought and the 1988 Alejandro
Angel Escobar National Science Award of Colombia.
Alex Pienkowski works in the International Finance Division of the Bank of
England as an economist. His recent focus of work has been on sovereign debt
restructuring, in particular potential reforms to reduce the incidence and cost
of debt crises. Prior to working in the Bank of England, Alex was an Overseas
Development Institute Fellow working in Malawi.
Rohan Pitchford is a Professor of Economics at the Australian National
University. Pitchford’s research has examined debt and default, ranging from
that of the firm through to nation states. He has studied the impact of debt
and default on welfare, and the potential of government and legal policy to
improve welfare.
Pablo Sanguinetti is the Socioeconomics Research Director at CAF (Andean

Development Corporation). He is Professor of Economics at Universidad
Torcuato Di Tella in Buenos Aires. He holds a MA (1989) and Ph.D. (1992)
degrees in Economics from University of California, Los Angeles. His research
interest includes international trade and integration, economic development
and fiscal federalism. He has published articles in Economics and Politics, the
Journal of International Economics and the Journal of Development Economics and
in several other journals and books. He has occupied visiting scholar positions at the University of New Mexico (1994), the University of Texas (A&M)
(1999) and the University of Bonn (2004). He has been member of the editorial board of the Latin American Research Review (LARR). He has worked
as consultant for the World Bank, Inter-American Development Bank, the
Economic Commission for Latin America and the Caribbean (ECLAC) and
Corporación Andina de Fomento (CAF). He has served as Member of the Board


xvi Notes on the Contributors

of the International Trade Commission of Argentina in 1996–2000 (Comisión
Nacional de Comercio Exterior).
Alfredo Schclarek Curutchet is Assistant Professor at the National University
of Córdoba, Argentina, where he teaches macroeconomics to both undergraduates and postgraduates. He is also Assistant Researcher at the National Scientific
and Technical Research Council, Argentina (CONICET) and Academic Director
of the Center for Participatory Research in Economic and Social Policies
(CIPPES). He holds a Ph.D. in Economics from Lund University, Sweden. He also
earned a Master’s and a BA in Economics from Lund University. He has studied
in Argentina, Canada and Sweden. He has worked at the European Central
Bank, Germany, the United Nations, Denmark and the National Agency for
Investment Development, Argentina. He has won several awards including
the Prize “Ten Outstanding Young Persons of the Year 2007,” Cordoba Stock
Exchange and Economic Research Annual Award 2007, Category: Young
Professionals, Central Bank of Argentina.
Benu Schneider is a well-established economist whose insights and technical

acumen have gained her respect in the profession. She has been working on
external debt and development finance issues, including stakeholder meetings
and consultations at the Financing for Development Office, Department of
Economic and Social Affairs, United Nations. She has also been based at the
Globalization and Development Strategies Division of UNCTAD, where she
led technical assistance efforts for countries preparing for Paris Club negotiations on debt restructuring and served as the UNCTAD observer representative
at the Paris Club. Prior to joining the UN, she held a professional position
at the Overseas Development Institute where she conducted policy oriented
research and advisory work on capital account liberalization, capital flight and
international standards and codes. During her career in India, she held the
position of Professor at ICRIER, a leading think-tank and was also the fulltime advisor at the Reserve Bank of India, specializing monetary policy and
the management of capital flows. Dr Schneider holds a doctorate from the
University of Kiel, Germany, and is the author of several books and papers on
international finance. She has combined academic and consultancy work with
hands-on policy advice and technical assistance to countries, which particular
focus on macroeconomic policies and domestic financial sector reforms. She
has authored many policy papers, including one analysing the Indian money
market for the Narasimham Committee of Banking Reform; the recommendations of which have had considerable influence and been implemented.
In 1997 she provided technical support to the Indian Committee on Capital
Account Convertibility, which laid the path for a gradual approach to capital
account liberalization.


Notes on the Contributors

xvii

Hernán Seoane is Assistant Professor at the Economics Department at
Universidad Carlos III de Madrid. He obtained his MA and Ph.D. in Economics
from Duke University and his BA in Economics from Universidad de Buenos

Aires, Argentina. His research focuses on open economy macroeconomics,
monetary and fiscal theory and policy and Bayesian econometrics.
Joseph E. Stiglitz is University Professor at Columbia University. In 2001, he
was awarded the Nobel Prize in Economics for his analyses of markets with
asymmetric information. He is currently the President of the International
Economic Association (2011–2014).
Federico Weinschelbaum is Associate Professor of Economics and Chair of the
Economics Department at Universidad de San Andrés, Argentina. He specializes in microeconomic theory, game theory, uncertainty and information and
political economy. He has published in the Economic Journal, the International
Economic Review, the European Economic Review, and the Journal of International
Economics. Born in Buenos Aires, Argentina, he obtained his Ph.D. in Economics
from University of California Los Angeles.
Mark L.J. Wright is a senior economist and research advisor on the macroeconomics team in the economic research department of the Federal Reserve
Bank of Chicago. His research examines the macroeconomics of developing
countries, with a specific focus on their tendency to be prone to international
financial crises. Much of his recent work has been devoted to sovereign default,
and the process by which sovereign debts are restructured.
Lei Zhang joined the Economics Department at Warwick after completing
his Ph.D. there. He has had visiting positions at the University of Iowa, at
Peking University and, more recently, at Sichuan University. Sovereign debt
problems and their resolution have been a key topic of research (see his paper
“Sovereign Liquidity Crises,” Economic Journal, 2000). He has also written on
“moral hazard” in the US stock market, on behavioral explanations of excess
volatility in FX markets, and on political uncertainty and the peso problem.
In response to the recent financial crises the focus of his research has been on
banking and financial stability. Lei has recently been investigating the application of network theory to banking systems, an approach he plans to pursue
further as a Houblon Norman Fellow at the Bank of England.


Introduction

Joseph E. Stiglitz and Daniel Heymann

Macroeconomic debt crises have been a part of the economic scene ever
since the emergence of modern credit markets. Sovereign defaults go further
back in history.1 From time to time, a certain consensus has arisen among
influential economists, policymakers and economic agents that crises are “a
thing of the past,” at least in some countries which appear to have gained
immunity for some reason or other. This complacency has been repeatedly
disappointed – and was probably a major factor in its own disappointment:
it is in the nature of those economic storms that they gather strength more
easily when they are less expected (Kindleberger, 1978). Various economies,
particularly but not only those labeled “emerging,” have experienced a
considerable number of crises, especially in the last 30 years (Reinhart and
Rogoff, 2009). The recent Great Recession in the world economy and the still
open Euro Zone crisis have shown that highly developed central economies
can also be vulnerable to debt-related macroeconomic disturbances of the
first order of magnitude.
Some decades ago, Hicks (1967) remarked that macroeconomics (or monetary theory) “... belongs to monetary history in a way that economic theory
does not always belong to economic history ... Monetary theories arise out of
monetary disturbances ...” The argument applies especially to the analysis of
macro crises, given their high social costs and theoretical interest. In fact, the
study of critical events has a long history, starting much before the coining
of the term “macroeconomics,” as illustrated by the classic works of the nineteenth century, from Thornton (1802) to, say, Bagehot (1873), passing through
Marx (1867–94). We still have much to learn, though.
The reflection on macroeconomic crises requires theoretical frameworks
that do not rule out as a matter of principle the very phenomena being studied.
Crises put into doubt the relevance of models that assume that self-equilibrating
mechanisms work automatically in the economy and that economic decisions
are based always and everywhere on a correct perception of the properties
1

2 Life After Debt

of the environment, even if possibly subject to random “exogenous” shocks
extracted from a known distribution.
Real-world macroeconomic crises typically trigger widespread and “fundamental” re-evaluations of the economy’s prospects, and an intense search for
lessons to be drawn for theories and policies. This implicitly presumes that
critical events supply material for redefining prior perceptions: the post-crisis
macro model (which will be used to interpret pre-crisis behaviors in retrospect)
is likely to differ substantially from the previously prevalent representations of
the economy. The activity appears paradoxical if carried out under the precept
that agents must be assumed unconditionally to form rational expectations and
that, consequently, there remains nothing for them to learn about the functioning of the economy (Stiglitz, 2011; Leijonhufvud, 2009; Heymann, 2007,
2008). The analysis of macro crises can certainly make good use of rational
expectations models to represent some aspects of the events in question. At
its core, however, trying to understand crises means developing preliminary
schemes to picture situations where agents (and very likely, also economists)
are hit by a realization that the economy did not work as they had thought it
would.
Beyond that, crises pose severe, and sometimes dramatic, policy problems,
at the national and international levels. There is a challenging task ahead in
searching to diagnose macroeconomic vulnerabilities, designing preventive
measures, finding ways to manage critical disturbances if they do develop, and
improving the chances of a good “life after debt,” as our title goes. The works
collected in the volume aim at contributing to that activity.

A family of events
Economies in crisis: a heterogeneous collection
Crises are often bunched in time and place. We usually speak of the Latin

American episodes of the 1980s, or the Asian crises in the following decade.
These commonalities may reflect shared structural features, which make
economies collectively sensitive to some classes of international impulses
and various “contagion effects,” or direct interdependences through trade
or financial channels; behavioral similarities may also play a relevant role
(for example, in the response to their crises of the 1980s, countries of the
Southern Cone of Latin America adopted macro and reform policies which,
although clearly not identical, showed analogous features). However, specific cases have their own idiosyncrasies. The set of episodes that can be
readily categorized as debt crises show diverse characteristics in a variety of
dimensions.
An often-made critical distinction is between crises which begin in the
public sector – with the inability of governments to repay what they owe and


Joseph E. Stiglitz and Daniel Heymann

3

to roll over their outstanding debts – and those that begin in the private sector.
Argentina and Greece belong to the former category; the 2008 crisis belongs
to the latter. But the distinction is not always clear: a private sector crisis can
easily morph into a public sector problem, for example, when there is socialization of private debts, as happened both in the US and East Asian crises.2
There is, however, one important distinction between crises brought on by
the inability of the private and the public sector to repay debts. In the former
case, there is a clear legal framework of what should happen when a firm cannot
(or is not willing to) pay what it owes. (There are, of course, complex problems
that arise when there are systemic crises, with large numbers of firms going
bankrupt.)3 But in the case of sovereign default, matters are more ambiguous.
There is no clear legal framework, and it is not easy to ascertain whether a
country could repay if it wanted to, for example, by raising taxes sufficiently.

Another important distinction often made is between crises which are a
matter of liquidity and those which are a matter of solvency. In the former case,
the presumption is that the borrower could eventually repay what is owed – the
borrower is simply not able to repay the amounts owed now, and can’t find
anyone to lend him the money. But the distinction is not so clear: if it were
evident that the borrower is solvent, then presumably someone would be willing
to make the loan. Typically, the debtor cannot get access to funds because no one
has confidence that it can/will repay. Of course, the borrower may believe he
is “solvent,” and is only facing a temporary problem. But the borrower faces a
liquidity problem because no potential lender shares that optimism.
Of course, ex post, it turns out that in some of the cases where this pessimism
prevailed, the borrower does recover. The provision of liquidity by a “lender
of last resort” (or the provision of funds to a country by the IMF) can “work,”
in the sense that the loans are repaid and the borrower goes on to experience
economic growth. Brazil (1998) provides a case in point. But there are many
cases to the contrary: Russia did default, and even when the lender of last resort
(the IMF) gets repaid, it may be largely at the expense of other creditors, who
de facto become junior to the IMF debt.
There is a tendency to look at the factors that seemed central to the last crisis
as central to determining any country’s vulnerability to future crises. In the
aftermath of the Latin American crises of the 1980s, the focus was on public
sector indebtedness; but excessive government spending played little role in
the next crisis, the Mexican “Tequila” crisis of 1994–95, and no role at all in
the East Asian crises of 1997–98: the governments had run surpluses. Mexico’s
low savings rate was sometimes blamed for that country’s crisis, but the East
Asian countries had high savings rates.
After East Asia, the focus shifted to the relative size of a country’s short-term
indebtedness that is denominated in foreign exchange; but the North Atlantic
financial crisis of 2008 showed that that variable was not so critical.

4 Life After Debt

Many critics of East Asia placed the blame on those countries’ lack of transparency. While transparency is clearly important – if one had all the relevant
information, clearly one wouldn’t lend to someone who would not be able
to repay – there have been crises in the most transparent countries, those in
Scandinavia.4
The quest for finding the variables that would determine, or at least predict,
vulnerability to a crisis has been largely futile (Furman and Stiglitz, 1998). Part
of the reason is the rich heterogeneity of circumstances of different countries.
Economies large and small, central and peripheral,
rich and less rich
Episodes of debt-related crisis in the last few decades have involved some of
the largest world economies (the US and Japan, among them) and others of a
substantially smaller size. Debt crises would seem more frequent in middleincome economies, but over the decades a number of episodes have originated
in wealthy countries. (Because very poor countries often have very limited
access to credit and have very underdeveloped financial sectors, such crises are
less likely to occur there.)
Financial systems with different sizes, configurations, sophistication of assets
A macroeconomic debt crisis obviously cannot develop without the fuel of a
substantial mass of financial obligations. That being given, crises have been
observed in economies with quite different degrees of financial depth (or
financialization). The stock of financial assets/liabilities in the US before the
recent crisis was several times larger than the annual value of GDP, and famously included a sizable volume of highly complicated derivatives, which were
meant in principle to improve the allocation of risks and reduce systemic fragility, but may have ended up doing the opposite.
However, in other instances, “innovative” financial products did not feature
prominently.5 Crises have occurred in financial systems operated mostly on
the basis of traditional bank lending and simple bonds. (Indeed, traditional
Minsky credit cycles are associated with plain vanilla banking.)
The denomination of the debt

In countries like the US and Japan, the national currency served as the usual
unit of denomination of a credit. In contrast, the Argentine crisis of the early
2000s occurred in an economy with relatively low ratios of liabilities to GDP
before the collapse, but where most of the debts that went into default consisted
of simple, dollar- denominated instruments.
Typically, governments that issue debt in their own currency cannot face
a conventional sovereign debt crisis: formal repayment can be accomplished
simply by turning on the printing presses.6


Joseph E. Stiglitz and Daniel Heymann

5

So too, governments that have borrowed in their own currency can reduce
the real value of what they owe through inflation (if they have long-term debt.)7
But, while seigniorage financing in moderate volumes may be an effective
instrument of debt reduction, so long as inflation remains mild, strong doses
are likely to prove disruptive. A government that is perceived to be engaged in
inflationary policies may not be able to get access to new funds, and the sudden
stop of an inflow of credit can itself precipitate a crisis.
Varieties of monetary, exchange regimes and policies
Debt crises occur in countries with a range of exchange rate systems. It used
to be thought that the best exchange rate regimes were the polar cases – either
rigidly fixed or freely floating, and that managed exchange rate regimes were
particularly vulnerable. On this basis, the IMF recommended that countries adopt one of the polar forms. But we have seen crises in countries with
“pure” floating regimes (US, Japan), as well as those with currency boards
with rigid convertibility (as rigid as can be – since in practice even “strictly
fixed” exchange rates do change) at a constant rate (for example, Argentina
1991–2001). They occur too in circumstances where there has been integration

into a regional monetary area (for example, Greece). Crises can occur under
an autonomous national monetary management, and also in the complete
absence of a country-specific monetary policy. Debt troubles may emerge in
very different inflationary environments. To mention examples of a single
country, the Argentine collapse of 2001/2002 was preceded by a period of
nominal deflation, while the crisis of the early 1980s developed in a context of
high inflation (over 80 percent a year).
Capital inflows, not always
The accumulation of ultimately unsustainable foreign debts (by governments
and/or private sectors) as the counterpart of current account deficits was
a feature of a variety of crises, especially in emerging economies. But asset
market bubbles and domestic financial boom–bust cycles also arose in economies (Japan, the US in the 1920s) which ran international surpluses and had
positive net lending flows to the rest of the world.
Government or twin deficits, sometimes
In some instances, difficulties in servicing the public debt, or outright government default, are at the epicenter of the macroeconomic quake. Lax fiscal
policies in the boom can also indirectly stimulate an unsustainable spending
and borrowing expansion of the private sector in open economies with access
to foreign credit. “Twin deficits” have been a salient element of crises, for
example, in Greece recently, and in several Latin American episodes. However,
there are other cases where the origin of a crisis can be identified directly


6 Life After Debt

in private sector over-indebtedness, with the government running measured
surpluses (as, for example, with the cases of Ireland in the 2000s, or Chile in the
buildup of its crisis in the 1980s). The connection between public and private
budget constraints works in both phases of the cycle. A “bubbly” growth in
private spending can transitorily boost fiscal revenues. But this may mask what
would appear to have been in retrospect the buildup of large contingent liabilities for the public sector, if after a crash the government engages in bailout

operations to rescue troubled groups of private debtors.
Family characteristics: broken promises and frustrated
wealth expectations
Macroeconomic debt crises, with all their heterogeneity, have a common defining
feature in the (actual or feared) non-fulfillment of large masses of financial
obligations. Bankruptcy and default are incompatible with perfect foresight.8 A
default perfectly and unanimously anticipated from its origin will not happen
(because no one will advance resources against an empty promise).
Thus, debt crises can only be studied in models in which there is uncertainty – in which at least at the time loans are made, the lenders think there
is at least some chance of being repaid. Of course, for all but a few borrowers,
lenders recognize that there is a chance of non-repayment, and thus demand
an interest rate that is in excess of the safe rate of interest (and greater than the
rate paid by the US government for a loan of comparable maturity). In principle, the non-execution of a payment commitment written as if it should be
realized unconditionally, could possibly be viewed as implementing an implicit
contingency clause in the contract. Non-payment would then represent what
everyone should, and does, expect according to the contract under the observed
circumstances. Luck determined a bad outcome from a distribution of external
conditions which, by assumption, was optimally contemplated by the parties
when they agreed on the contract. What went wrong was due to blind chance:
it may be deplored, but should cause no regrets to anyone.
The argument just mentioned points to the ambiguity of the notion of default.
The existence of interest premiums implies that, somehow, the prospect of
non-payment of the debts in certain states of the world has been contemplated
as part of the “normal course of events.” Also, in assessing the profits and losses
of the parties in a contract, it should be considered that a lender is hurt when
a stream of promised payments is interrupted, but the damage could be (and,
on average, in a world with a modicum of rationality, would be) more than
offset by the profits from holding high-yield claims before default occurred. In
this view, debt restructurings are both anticipated (in the sense that creditors
know that these restructurings will happen under certain contingencies) and

are welfare increasing, since implicitly, what appears as a pure debt contract
contains within it an element of equity, of risk sharing.


Joseph E. Stiglitz and Daniel Heymann

7

Such restructurings need not lead to crises. Indeed, the large declines in
incomes often observed in debt crises (in this perspective) are not because
of the debt crisis so much as because of the adverse shocks that led to the
crisis; the debt restructuring can be an important element in helping countries
absorb such adverse shocks.
But when there is a large amount of debt, adverse shocks can lead to a crisis
for a slightly different reason: in a world with credit rationing, the adverse
shock, if large enough, can lead to a sudden cessation of the flow of credit from
abroad, with severe macroeconomic consequences (Gersovitz et al., 1986).
We should note that for developing countries (and increasingly for developed
countries) the adverse shocks are often not something that happens internally,
but a change in the flow of funds abroad, as a result, for instance, of a change
in monetary policy in the United States or a change in risk perceptions.
However, for the most part crises do not correspond to the image of events
which, though unpleasant, can be taken serenely as part of a well-defined
“natural randomness of things.” Crises negate rational expectations. It is
not just that a bad outcome that they realized might happen has happened.
Typically, crises lead to changes in views of the world. They are memorable
incidents that remain in the minds of people who live through them, and
often serve as historical landmarks long after their time. For large groups of
people, a crisis does not call for moving ahead along a particular branch of a
predetermined decision tree. Rather, agents living in a crisis perceive potentially life-changing transformations in their environments, calling them to

reconsider attitudes, beliefs and behavior patterns. Policymakers are likely to
be in the same predicament: the crisis proved them wrong (those in power, at
least) and now they, and society as a whole, must come to a new understanding
of the world, and in doing so find their way out of a mess.9
The Queen of England famously asked about the financial crisis in the UK
“It’s awful ... Why did nobody see it coming?” The answer was not that the
economy had been hit by a well-identified shock whose likelihood of occurrence was known to be given by certain probability distribution. Rather, some
years later (December 2012, in a visit to the Bank of England), the Queen
answered her own question: “People got a little lax ... perhaps it´s difficult to
foresee [a crisis].”10 By the very nature of debt crises, the difficulty that many
people find in anticipating their appearance is an intrinsic part of the process
that generates them.
Crises substantially modify the scenarios where people carry out their economic activities. They represent a point of discontinuity: Most importantly,
from a macroeconomic perspective, large groups perceive themselves, and
the economy as a whole, poorer than once thought. These are “awful” events,
where the estimates of a country’s wealth get revised downwards. And this
leads to marked changes in behavior.11