Strategy to deflate systemic debt and to support growth

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For a country where there is no monetary sovereignty, systemic debt deflation via quantitative easing is not possible 


Deflating systemic debt means reducing debt burden in the economy by design. Sometimes debt deflation takes place by accident. Let us discuss this subject within the Sri Lankan context.

Sri Lanka printed money during the presidency of Gotabaya and prior to that. They printed money without limit. This was bad and this habit was changed on the strict advice of the IMF. Now, CBSL insists that “with the introduction of the Central Bank of Sri Lanka Act, No. 16 of 2023, which came into effect in September 2023, the CBSL is now prohibited from printing money through the purchase of Government securities in the primary market to fund the Government” (CBSL Press Release on 29 Oct. 2024). However, this is a gross violation of our monetary sovereignty which refers to the authority and capacity of our country to control our own currency and monetary policy. Why does a country need monetary sovereignty?

Having an independent, sovereign currency provides several benefits, particularly in terms of economic flexibility, control, and resilience. If we cannot print money, at least subject to a monetary rule, we will lose these benefits. Here monetary rule means that we should expand the monetary base subject to a certain percentage (e.g. 1%) of GDP. Then, without monetary sovereignty, we can’t do our own version of quantitative easing. We can’t do systemic debt deflation and support economic growth. We can’t get an advantage over international terms of trade. And finally, under the given circumstances Sri Lanka will be a failed State for a long time.

Printing money, subject to the said monetary rule, does not create inflation, if the Treasury and the CBSL can contain total credit growth.



Two strategic approaches

When a country hits a debt crisis whether it is a developing country or developed country, that country should have at least two strategic approaches to resolve the crisis. Recently, a popular strategy is quantitative easing which is the expansion of the central bank’s balance sheet creating new money. The other strategy is the system wide deflation of debt because no country can pay all the debt when a debt crisis hits and hence deflation of systemic debt could be a better approach. 

Both these strategies are closely connected. Or else go hand in hand. Systemic debt deflation cannot be done without expanding the monetary base or without quantitative easing. Therefore, for a country where there is no monetary sovereignty, systemic debt deflation via quantitative easing is not possible. This is the true case of Greece. It lost its monetary sovereignty to the European Central Bank.

Research done after the Great Recession of 2008-09 in the United States, it points out that a minimum wage increase of 70% might create a 3 to 4% inflation. Then, increased wages can reduce debt burden. This means wage increase bound moderate inflation is a strategy to deflate debt system-wide.



Moderate wage increases alongside controlled inflation

Accordingly, moderate wage increases alongside controlled inflation can help reduce the relative burden of debt in an economy. Here’s how this works and why it can be beneficial:

First, moderate inflation gradually reduces the real (inflation-adjusted) value of debt. When wages and prices rise modestly over time, existing debt becomes “cheaper” in real terms. This effect can help both individuals and Governments who have fixed-rate debt obligations, as they repay loans with money that is relatively less valuable than when they borrowed it.

Secondly, when wages rise with moderate inflation, people have more income to meet their debt obligations, reducing the risk of default. This helps maintain a stable financial system and supports consumer confidence, which is critical for economic growth. Higher wages also mean more disposable income, which can drive consumer spending and boost the economy.

Thirdly, moderate inflation with wage increases can encourage investment. When debt loses value over time, businesses may feel more comfortable taking on new investments, as the relative burden of debt is easier to manage. For developing countries, this can drive growth in industries and job creation.

However, challenges and risks could exist because even though moderate inflation and wage increases can reduce the relative burden of debt, managing this balance is difficult. If wages grow too quickly or without matching production increases, inflation can spiral out of control, eroding purchasing power and leading to instability. By limiting the total credit growth, the Government can prevent excess money from chasing too few goods, which helps keep inflation in check. This allows money supply to grow in a way that supports economic activity without creating severe price instability.

According to the information I have, just 1% of the expansion of the monetary base can support nearly 30% salary increase while keeping inflation in check with mild increase, if total credit growth can be contained appropriately. However, under the given circumstances Sri Lanka needs to have the permission to increase its monetary base or print money subject to a monetary rule.

The most important fundamental factor is that the Government including the Treasury and CBSL should identify or understand that the economy is a disequilibrium system rather than an equilibrium system. This philosophical understanding decides what monetary and economic strategies are available for the Government to resolve a severe systemic debt crisis and to ensure resilient economic growth even with the support of multilateral financial institutions.  


(The writer could be reached via email at [email protected].)

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