«We’re really way out in
uncharted territory»

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Carmen Reinhart, how high are levels of public debt currently?

As far as I can tell, we are at record highs on a global basis, surpassing even the major wars of the last centuries. And that is just public debt, not to mention private debt that often becomes public debt after a crisis. If we take into account that private debt is also very high, then we’re really way out in uncharted territory.

How did this come about?

There is no single explanation, it’s certainly been evolving over a substantial period of time. Back in the 1980s, when Paul Volcker tightened monetary policy and was able to jack up rates very sharply, household debt in the US was about half of what it is today. Since then, we have had a 40-year period with different modalities of a steady rise in debt levels, but the last 15 years have been spectacular. Part of the story is certainly «low for long»: the exceptionally low-interest rates that have made borrowing cheap. In the case of Europe, the historical anomaly of outright negative nominal interest rates is an invitation to overborrow. For both the public and the private sector, highly negative real interest rates are nothing but a transfer from savers to borrowers. And of course, big events such as the global financial crisis and the COVID pandemic have also added a lot of debt.

You mentioned the exceptionally low interest rates of the last decades. The past year has seen a shift of mood: Central banks tightened their policy in response to inflation. What are the consequences?

Naturally, this came as a response to an inflation spike that reached levels not seen in the last 40 years. Most economists initially interpreted the spike as a transitory phenomenon caused by the aftermath of the pandemic, supply shocks and a variety of other transitory factors. Most central banks misjudged the situation: Instead of treating inflation as a serious threat early on, the tightening came a little too late. Personally, I have been fearing a more persistent level of inflation for a couple of years now. Historically, there have only been a few episodes since the 1800s where short-term real interest rates were persistently negative: The years around World War One, the years around World War Two, and the 1970s. The period since the global financial crisis is the fourth time we’ve been there.

What can we learn from the earlier periods?

In periods of low interest rates, you get more borrowing, meaning more money in circulation and eventually higher price levels: All of those episodes mentioned were inflationary. Exiting negative real interest rates is a must if we’re serious about inflation stabilization. The shift has been overdue. And let’s hope it lasts: With the adverse supply shocks still around, there is the danger that central banks get cold feet and back out early of fighting inflation.

Won’t the shifting environment in monetary policy cause economic problems in indebted countries? Are we in danger of a global debt crisis?

I would not yet call it global but we are definitely seeing debt problems surface more frequently and aggressively. The canary in the coal mine are the low-income countries: In these countries, there is a combination of rising debt levels in hard currency, now rising interest rates, and slower growth. In many cases, an outright shortage of foreign exchange means that debt servicing has faltered. Some Sub-Saharan African countries have applied for international support under the Common Framework, a G20 guideline…