november 11, 2010

Paper Recommendation: Is it really different this time?

I would like to recommend a nice paper by Reinhart and Rogoff (2008), This Time is Different: A Panoramic View of Eight Centuries of Financial Crises

The article ahs since become a book but the article is nice as well. It deals with five kinds of economic crises:

(i) external default
(ii) domestic default
(iii) banking crises
(iv) currency crashes
(v) inflation outbursts

The study covers many centuries of data and I find many interesting facts regarding crises. One of the more interesting parts of the paper is the one dealing with external versus domestic debt. For instance, the authors show that domestic debt has long been as significant as external debt in meeting emerging market financing needs. This is contrary to the common assumption today that emerging countries increasingly rely on domestic debt. Since I believe that the assumption possibly is one factor supporting the high valuations and low credit spreads in these countries this is an important finding. In addition, Reinhart and Rogoff show that defaults on domestic debt appear to be associated with similar magnitudes of output loss as defaults on external debt. Again, interesting!

I think a comparison of the extent of domestic and external debt in some euro-countries could shed some light on the relative vulnerability of these countries (Italy?) that the market has not picked up yet. I will be back on this issue.

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PS. Another interesting and related result found in the paper is the share of years a country has been in default since the year the country gained independence. Notable examples are Sweden (0%), Germany (13%), Spain (24%), Hungary (37%) and Greece (50%)!! Incidentally (?) the ranking is the same as Buttonwood’s ranking of the size of the debt trap of these countries (see The debt trap: ranking the suspects).