Time to Go Crouch in the Basement...
Liveblogging World War II: December 13, 1940

Yet Another One from Nick Rowe


"Illiquid" and "insolvent" are not clearly distinguished:

Nick Rowe: Worthwhile Canadian Initiative: Sovereign insolvency and illiquidity: If a country has a debt/GDP ratio of 100%, and is paying 9% interest, and nominal GDP is not rising, then it's got a solvency problem. It needs to run a budget surplus of 9% of GDP just to stop the debt/GDP ratio rising further. And that is very hard to do.

But why would a country ever be paying 9% interest and have 0% nominal GDP growth? By David Beckworth's simple, crude, but nevertheless useful measure of the tightness of monetary policy -- the gap between nominal interest rates and expected nominal GDP growth rate -- a gap of 9 percentage points is very tight monetary policy. No country that had control over its own monetary policy would set monetary policy that tight (OK, unless its population were falling exogenously at around 9% per year, or if it were a purely temporary measure to reduce entrenched inflation).

Countries like the UK, US, Japan, have large debts and deficits. But they control their own monetary policy, and none of them have monetary policy anywhere near that tight. If they did set monetary policy that tight, they too would have a solvency crisis.

Ireland has a solvency crisis, but only because it has a liquidity crisis. Ireland does not control its own monetary policy. Money is the most liquid of all assets.

If monetary policy were less tight, so the gap between nominal interest rates and nominal GDP growth were 1%, a country with a 100% debt/GDP ratio would only need a budget surplus of 1% of GDP to prevent the debt/GDP ratio from rising. That's doable. That country is solvent.