Media Briefings

Prospects For Public Debt Default And High Inflation: Lessons From The Forgotten History Of Domestic Debt

  • Published Date: May 2011

With surging domestic public debts in most advanced economies since the financial crisis
began in 2007, research published in the May 2011 issue of the Economic Journal
describes the forgotten history of domestic debt – its significance as a proportion of total
public debt, and when it has led to outright default, reschedulings and inflation.
Professors Carmen Reinhart and Kenneth Rogoff have compiled a new database that
catalogues episodes of outright defaults on and reschedulings of domestic public debt
across more than a century. Among their findings:
 Domestic debt is and was large, averaging almost two thirds of total public debt
across the countries for which there are detailed data. The increase in the share of
domestic debt in the last few years is but an upward ‘blip’ in the larger context.
 Recognising the significance of domestic debt goes a long way towards explaining
the puzzle of why many countries default on – or restructure – their external debts at
seemingly low debt thresholds.
 Default on domestic debts is somewhat rarer than external default. But it is far too
common to justify the extreme assumption that governments always honour the
nominal face value of domestic debt.
 When there is outright default on domestic debt, it seems to occur under situations of
greater duress than for pure external defaults – both in terms of an implosion of
output and a marked escalation of inflation.
Reflecting on future prospects, the authors conclude:
‘Celebration about graduating from a history of serial default may be premature in
many countries, both advanced and emerging.
‘Governments that have repeatedly defaulted on their external debts, inflated away
or outright defaulted their domestic debts, will, in all likelihood, not hesitate to default
Domestic debt is not a new invention
In contrast with external sovereign debt, research and data on domestic debt are sparse.
But in the 64 countries for which the researchers have long time series, domestic debt
averages almost two thirds of total public debt (see Figure 1).
For most of the sample, these debts typically carried a market interest rate, except for the
era of financial repression after World War II. From 1914 to the 1960s, before inflation
became a widespread phenomenon, more than a half of domestic debt was long-term, even
for Latin America.
Figure 1. Total (domestic plus external) and domestic debt as a percentage of GDP:
all countries, 1900-2010
The puzzle of ‘debt intolerance’
The significance of domestic debt helps to explain why many countries default on their
external debts at seemingly low debt thresholds. In fact, when domestic debt obligations are
taken into account (see Figure 2), fiscal duress at the time of default is often revealed to be
considerably more severe. Specifically, debt-to-revenue ratios are about twice as high for
total (domestic plus external) debt as the standard ratios that only considered external
Default through inflation
Domestic debt may also explain the paradox of why some governments seem to choose
inflation rates far above any level that might be rationalized by seignorage revenues
levered off the monetary base. (This was the puzzle first pointed out in Cagan’s classic
1956 article on post-war hyperinflations.).
Although domestic debt is largely ignored in the vast body of empirical research on high
and hyper-inflation, this study finds that there are many cases where the hidden overhang
of domestic public debt was at least the same order of magnitude as base money, and
more often than not, a large multiple (see Figure 3)..
Figure 2. Public debt-to-revenue ratios during external default: 90 episodes, 1827-2008
Figure 3
Outright defaults on domestic debt
Where there are domestic debts, there is also domestic default. The phenomenon is
somewhat rarer than external default, and appears to occur under situations of greater
Debt/revenue ratios during tranquil years,
selected countries, 1827– 2008
External Total
Argentina 1.4 4.3
Chile 1.4 2.1
Korea 2.0 2.6
Poland 1.4 1.6
So. Africa 0.1 2.0
Spain 1.5 8.7
Turkey 0.6 1.5
Average 1.2 3.3
Africa Asia Europe Latin America
Total (domestic plus
external) debt/ revenue
(dark bars)
Debt/ Revenue
(light bars)

duress than for pure external defaults – both in terms of an implosion of output and a
marked escalation of inflation.
As Figure 4 shows, in the run-up to a default on external debt, the economy is stagnant or
in recession (on average, real per capita GDP edges down slightly from its level four years
before the crisis). On the eve of domestic default, however, the output contraction is much
deeper, as GDP registers an average decline of about 8%.
Figure 4
It is important to note that this research does not catalogue episodes of major de facto
partial defaults, say through a sharp unexpected increase in financial repression (for
example, of the type China still imposes today).
Notes for editors: ‘The Forgotten History of Domestic Debt’ by Carmen Reinhart and
Kenneth Rogoff is published in the May 2011 issue of the Economic Journal.
Carmen Reinhart is at the Peterson Institute for International Economics. Kenneth Rogoff is
at Harvard University.
For further information: contact Romesh Vaitilingam on +44-7768-661095 (email:; Carmen Reinhart via email: CReinhart@PIIE.COM; or Kenneth
Rogoff via email: