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Willam Vickrey, 1996 Nobel Award in Economics

October 5, 1996

Debt would, it is held, eventually reach levels that cause lenders to balk with taxpayers threatening rebellion and default.

Relevant reality: This fear arises in part from observing crises in which capital-poor countries have had difficulty in meeting obligations denominated in a foreign currency, incurred in many cases to finance imports and ultimately requiring servicing and repayment in terms of exports, the crisis often arising because of a collapse in the market for the exports. In the case at hand the debt is intended to supply a domestic demand for assets denominated in the domestic currency, and in the absence of a norm such as a gold clause, there can be no question of the ability of the government to make payments when due, albeit possibly in a currency devalued by inflation. Nor can there be any question of balking by domestic lenders as long as the debt is limited to that needed to fill a gap created by an excess of private asset demand over private asset supply.

It is not intended that the domestic government debt should be held in any large quantity by foreigners. But should foreigners wish to liquidate holdings of this debt or any other domestic assets, they can only do so as a whole by generating an export surplus, easing the domestic unemployment problem, releasing assets to supply the domestic demand, and making it possible to get along with smaller deficits and a less rapidly growing government debt. The same thing happens if domestic investors turn to investing in foreign assets, thereby reducing their drain on the domestic asset supply.
In a panicky market it might happen that the market price of assets might fall sufficiently rapidly so that the total market value of the assets available to meet the domestic demand might fall. In such a case a temporary increase in government deficits rather than a decrease would be in order. Arranging this on short notice may be difficult, and the danger of overreacting or poor timing is real. Something more than mere pious declarations that the economy is fundamentally sound, however, is called for. Nevertheless, one cannot entirely rule out the possibility of this becoming a panic-generating self-fulfilling prophecy derived from concentrating attention on the financial symbols rather than the underlying human reality. In Roosevelt's terms, the main thing to fear is fear itself.