Carmen M. Reinhart Quotes

These crises are really a form of domestic default that governments employ in countries where financial repression is a major form of taxation. Under financial repression, banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payments system, not simply currency. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form of taxation. Citizens put money into banks because there are few other safe places for their savings. Governments, in turn, pass regulations and restrictions to force the banks to relend the money to fund public debt. Of course, in cases in which the banks are run by the government, the central government simply directs the banks to make loans to it.

Theoretical models encompass a wide range of assumptions about domestic public debt. The overwhelming majority of models simply assume that debt is always honored. These include models in which deficit policy is irrelevant due to Ricardian equivalence.7 (Ricardian equivalence is basically the proposition that when a government cuts taxes by issuing debt, the public does not spend any of its higher after-tax income because it realizes it will need to save to pay taxes later.) Models in which debt is always honored include those in which domestic public debt is a key input in price level determination through the government's budget constraint and models in which generations overlap

The lesson of history, then, is that even as institutions and policy makers improve, there will always be a temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be.

The danger, of course, is that it is not always easy to distinguish between a default that was inevitable - in the sense that a country is so highly leveraged and so badly managed that it takes very little to force it into default - and one that was not - in the sense that a country is fundamentally sound but is having difficulties sustaining confidence because of a very temporary and easily solvable liquidity problem. In the heat of a crisis, it is all too tempting for would-be rescuers (today notably multilateral lenders such as the IMF) to persuade themselves that they are facing a confidence problem that can be solved with short-term bridge loans, when in fact they are confronting a much more deeply rooted crisis of solvency and willingness to pay