Debt Restructuring

What difference does it make, and for whom, whether the nonperforming debts of emerging market borrowers are restructured? This paper begins by positing a set of counterfactual conditions under which restructuring would not matter, and then shows how several ways in which the actual world of international lending departs from these conditions give both lenders and borrowers ample reason to care whether nonperforming debts are restructured. One implication of the way in which debt restructuring matters is that restructuring should not be too' easy. Further, with a greater frequency of defaults, some credit flows to emerging market countries would not be extended in the first place. An important element driving this line of argument is moral hazard, but (unlike in much of the recent literature of emerging market debt problems) what is central here is not the availability of credit from the IMF or other official lenders but the more fundamental moral hazard inherent in all uncollateralized borrower-lender relationships.

New Directions in the Relationship Between Public and Private Debt

Until the 1980s the outstanding indebtedness of government and private-sector borrowers in the United States exhibited sufficient negative covariation that total outstanding debt remained steady relative to nonfinancial economic activity. Three hypotheses -- one based on lenders' behavior, one on borrowers? behavior, and one on credit market institutional arrangements -- provide potential explanations for this phenomenon. Since 1980 the U.S. debt markets have departed from these previously prevailing patterns, however, as both government and private borrowing have risen sharply.

The Greenspan Era: Discretion, Rather Than Rules

What stands out in retrospect about U.S. monetary policy during the Greenspan Era is the ongoing movement away from mechanistic restrictions on the conduct of policy, together with a willingness on occasion to depart even from what more flexible guidelines dictated by contemporary conventional wisdom would imply, in the interest of carrying out the Federal Reserve System%u2019s dual mandate to pursue both stable prices and maximum employment. Part of this change was procedural %u2013 for example, the elimination of money growth targets. The most substantive demonstration of policy flexibility came in the latter half of the 1990s, as unemployment fell below 6% (in 1994), then below 5% (in 1997), and then remained below 5% for more than four years, yet the Federal Reserve did not tighten monetary policy. This policy stance was consistent with a view of the economy, including faster productivity growth and increased exposure to international competition, that Chairman Greenspan had articulated nearly a decade before.

The Inefficiency of Short-Run Monetary Targets for Monetary Policy

macroeconomics, monetary policy

Economic Implications of Changing Share Ownership

Institutional investors, including especially pension funds and mutual funds, are steadily replacing individuals as owners of equity shares in the United States. Forty years ago individual investors owned 90% of all equity shares outstanding. Today the individually owned share is just 50%. The arguments and evidence surveyed in this paper suggest four ways in which this shift in share ownership could affect the functioning of the equity market: (1) Increasing institutional ownership could either enhance or impair the market's ability to provide equity financing for emerging growth companies. (2) Increasing institutional ownership, especially in the form of open-end mutual funds, has probably increased the market's volatility in the context of occasional large price movements. (3) The increasing prevalence of defined contribution (as opposed to defined benefit) pension plans, and especially of 401-k plans, has probably resulted in an increased market price of risk. (4) Increasing institutional ownership has facilitated a greater role for shareholders in the governance of U.S. corporate business, and correspondingly reduced the independence of corporate managements.

Increasing Indebtedness and Financial Stability in the United States

The U.S. economy's nonfinancial debt ratio has risen since 1980 to a level that is extraordinary in comparison with prior historical experience. Approximately one-half of this rise has consisted of increased indebtedness (relative to income) of borrowers in the economy's private sector, including both individuals and businesses, and it therefore at least potentially represents an increase in the economy-wide exposure to debt default. The U.S. household sector as a whole has increased its holdings of liquid and other readily marketable assets, so that in the aggregate its balance sheet is no less sound than before, but available data make it doubtful that the distribution of the additional assets matches the distribution of the additional debt closely enough to avoid debt service problems in the event of a general economic contraction. By contrast, in the case of businesses, including especially the corporate sector, there are no additional assets to match the additional liabilities, so that balance sheets as well as incomes have become more leveraged. The chief implication of this increased exposure to the threat of financial instability is not only that the U.S. economy is likely to be more prone to financial instability in the event of a major business contraction, but also -- and perhaps more importantly -- that, as a result, U.S. economic policymakers are likely to be more reluctant either to seek or to tolerate a business recession in the first place. Experience suggests that it will be difficult 'to balance the desire to avoid economic downturns with the ability to avoid occasional periods of aggregate excess demand, so that this increased reluctance to tolerate recessions probably implies a more expansionary monetary policy on average than would otherwise be the case. Experience also suggests that a plausible result of such a no-recession monetary policy, sustained over time, is price inflation. This process is self-limiting, however, in that over time inflation reduces the real value of the private sector's outstanding nominal indebtedness, hence reducing the risk of financial instability, and thereby removing the source of policymakers' increased reluctance to tolerate recessions.

What Have We Learned from the Reagan Deficits and Their Disappearance?

This paper looks again at the U.S. deficit debate of the 1980s, this time with the benefit of the Commerce Department's newly revised data for that period and also in light of the experience of the 1990s when sizeable budget surpluses replaced chronic large deficits. The familiar conclusion that sustained government deficits at full employment depress private capital formation has stood up well in both regards. By contrast, the more recent experience in particular has sharply contradicted any simple notion that the government balance and the current account balance move in parallel. Other relevant issues include the equilibrium (that is, noninflationary) unemployment rate, the response of private saving to government dissaving, and the role of debt and equity in financing private capital formation.

What remains from the Volcker experiment?

Volcker, Paul A. ; Monetary policy

Crowding Out or Crowding In? Evidence on Debt-Equity Substitutability

When the composition of assets outstanding in the market changes, the pattern of expected asset returns also changes, shifting to whatever return structure will induce investors to hold just the new composition of exisiting assets. The object of this paper is to determine, on the basis of the respective risks associated with the returns to broad classes of financial assets in the United States, and hence on the basis of the implied portfolio substitutabilities among these assets, how government deficit financing affects the structure of market-clearing expected returns on debt and equity securities traded in U.S. markets.The empirical results indicate that government deficit financing raises expected debt returns relative to expected equity returns, regardless of the maturity of the government's financing. More specifically, financing a single $100 billion government deficit by issuing short-term debt lowers the expected return on long-term debt by .06$100 billion deficit by issuing long-term debt raises the expected return on long-term debt by .10%, but lowers the expected return on equity by .24%,again in comparison to the return on short-term debt. These per-unit magnitudes are not huge, but in the current U.S. context of government deficits approximating $200 billion -- year after year -- they are not trivially small either.These results have immediate implications for the composition of private financing. In addition, in conjunction with some assumption (for example, about monetary policy) to anchor the overall return structure,they bear implications for the total volume of private financing, as wellas for capital formation and other interest sensitive elements of aggregate demand.