History of Public Debt

What happens if a large, high-income economy, burdened with high levels of debt and an overvalued, fixed exchange rate, attempts to lower the debt and regain competitiveness? This question is of current relevance, since this is the challenge confronting Italy and Spain. Yet, as a chapter in the International Monetary Fund's latest World Economic Outlook demonstrates, a relevant historical experience exists: that of the UK between the two world wars. This proves that the interaction between attempts at "internal devaluations" and the dynamics of debt are potentially lethal. Moreover, the plight of Italy and Spain is, in many ways, worse than the UK's was. The latter, after all, could go off the gold standard; exit from the eurozone is far harder. Again, the UK had a central bank able and willing to reduce interest rates. The European Central Bank may not be able and willing to do the same for Italy and Spain.