How to pay down debt
Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth.
Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly, and on a sufficient scale to restore sustainability. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit.
Some have suggested that higher inflation may be a way out from the burden of excessive debt. To be effective, this would need to be coupled with various forms of financial repression, including capital controls and forced holdings of government debt.
This is a counsel of despair.
An inflation surprise needs to be very large or very sudden to work. Moving opportunistically to a higher inflation target would risk unmooring inflation expectations, destroying the hard-won gains that have come from the entrenchment of price stability, and increasing real rates that would exacerbate unfavourable debt dynamics.
Financial repression would have to be both massive and sustained. It would undermine the system that has helped bring us the prosperity of the past three decades.
The most palatable strategy to reduce debt is to increase growth.
Private growth will not flourish in an environment of macro instability. Fiscal sustainability and price stability are essentials, not luxuries.
Private growth needs an enabling environment, including tax competitiveness and a framework for infrastructure investment. It needs a sound financial sector that is diverse, resilient and open.