Brookings Papers on Economic Activity

Debt Intolerance

Abstract

In this paper we argue that history matters: that a country’s record at meeting its debt obligations and managing its macroeconomy in the past is relevant to forecasting its ability to sustain moderate to high levels of indebtedness, both domestic and internal, for many years into the future. We introduce the concept of “debt intolerance” (drawing an analogy to, for example, “lactose intolerance”), which manifests itself in the extreme duress many emerging market economies experience at overall debt levels that would seem quite manageable by the standards of the advanced industrial economies. For external debt, “safe” thresholds for highly debtintolerant emerging markets appear to be surprisingly low, perhaps as low as 15 to 20 percent of GNP in many cases, and these thresholds depend heavily on the country’s record of default and inflation. Debt intolerance is indeed intimately linked to the pervasive phenomenon of serial default that has plagued so many countries over the past two centuries. Debtintolerant countries tend to have weak fiscal structures and weak financial systems. Default often exacerbates these problems, making these same countries more prone to future default. Understanding and measuring debt intolerance is fundamental to assessing the problems of debt sustainability, debt restructuring, and capital market integration, and to assessing the scope for international lending to ameliorate crises.