Resolutions to the Amassment of National Debt: A Historical Analysis

ABSTRACT

With Japan's rate of government debt (long term outstanding debt / GDP) now reaching 140%, there seems to be no end to the growth of the national deficit. Furthermore, no clear plan has been made as to how the government intends to pay these debts in the future.

The following report looks at historical cases in which developed countries have amassed debts and examines how these countries ultimately eliminated them. A total of 8 different cases were taken up for this analysis: America after WWI, after WWII, and in the late 1980s, England after the Napoleonic Wars, Germany after WWI, Italy in the early 1990s, Sweden in the early 1990s, and Japan after WWII.

These cases were studied from several perspectives: 1) What were the factors that led to the accumulation of debts? (Did the government have extensive military expenditures?) 2) What motivated the government to stop creating debt? (Did people begin to lose confidence in the currency?) 3) What factors led to the decrease in the rate of government debt? (Were government debts paid back? Was there economic growth? Was there a hike in commodity prices?)

In the cases studied, a sudden drop in prices and the resulting loss of confidence in the currency was most often the motivation for governments to clean up their debts. Frequently in such cases, market pressures put the economy into a state of panic and reform was carried out swiftly and unrelentingly. On the other hand, though they were exceptions to the rule, there were some cases in which reform was pushed forward gradually, step by step through internal, and not external, pressures.

In cases when it was difficult for the financial authorities to restructure on their own, they would band together with the central bank to prop up the government bond market and gently bring down the rate of government debt. But confidence in the currency was maintained even in the cases where the central bank's intervention was successful. Hyper inflation resulted in the instances when confidence in the currency was completely lost.

Theoretically speaking, the problem of getting rid of government debts ultimately comes down to the question of who will take the initiative to fulfill the budget constraint equation. Will the financial authorities take responsibility for it? Or will the central bank? It was historically confirmed that debt was dealt with by one or the other, or by the joint effort of both.

At present, both Japan's currency market and government bond market have heavily declined, implying that there is little chance for market pressures to come into play. Furthermore, looking at the current political situation, it is not likely that enough internal pressure will develop to push forward any type of financial reform. In order to bring about a soft landing for the government deficit - avoiding violent reactions from the market and a loss of confidence in the currency - it is necessary, above all, that the government impart to the public the urgency of the current financial crisis and set forth a demonstrably feasible plan for economic growth and financial restructuring. In implementing such a plan, the support of the central bank will be necessary.