Write down and get real

What can be learnt from these various approaches? It is still early days, but four lessons stand out. The first is that in some extreme cases, when a large debt reduction is needed, orderly write-downs are necessary. The foreclosures on American mortgages have been severe, but they mean that household debt is likely to shrink to manageable levels faster than in, say, Britain, where low interest rates on variable mortgages and a lot of “forbearance” by banks have kept defaults artificially low. At the sovereign level the same logic should apply to hopelessly bankrupt Greece: it needs a debt write-down.

Second, nominal growth is essential to bring down the weight of debt. It is hard to ease the debt burden in a stagnant economy with low inflation. That suggests the pace of public-sector austerity, where possible, needs to be calibrated to the scale of private deleveraging. America’s government, for instance, needs a medium-term plan for deficit reduction, but cutting back spending viciously in the short term at a time of private-sector retrenchment would be a mistake.

Third, the best way to ease the pain of deleveraging is with an export-led boom. Here, progress has been painfully slow. The external deficits of ex-bubble economies have shrunk since 2007, but not by enough—and some now seem to be rising again. There has been too little rebalancing of global demand towards big emerging economies. That will require stronger currencies in emerging Asia and weaker ones in the rich world.

Deeper shifts will also be necessary: a strengthening of consumer society in China, for example, and a reallocation of resources towards tradable goods and services in Britain and America. Unfortunately, the sensible goal of rebalancing towards net exports can lead to dubious policy prescriptions. Britain, for instance, would be mad to turn its back on financial services (see article). No rich country needs a smorgasbord of subsidies for manufacturing. Far better to get rid of distortions and improve the economy’s flexibility.

All this will take time. So the fourth, most important and most depressing lesson for the great deleveraging is that of realism. Even if handled well, the difficult business of debt reduction will hold back the rich world’s economies for several more years. Get used to it.



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