What should you do when you find out that you can’t pay your bills? You have two choices. You can default on your obligations or you can borrow money to make up the difference. If your obligations are denominated in your own currency, then you have the option of inflation to reduce the real value of what you pay your creditors. This is a form of default. It is not complete but it is a partial reneging on your obligations.
I recently tweeted (follow me @econtalker) that sometimes reducing spending isn’t a macroeconomic strategy but something that is forced on you by reality. One response you hear to this is that reducing spending is bad for your economy when you’re in a recession. Maybe. I’m not convinced. Could be, but even if it’s true, if people don’t want to lend you money anymore or only want to lend you money at an extremely unattractive rate, that fact that your past profligacy now demands an un pleasant solution is simply an aspect of reality.
Those who oppose spending cuts when the bond market no long likes you reminds me of a metaphor I recently heard from a student at SMU when I visited the campus (and if that student reads this, please email me and remind me of your name.) He used the metaphor of a restaurant patron who discovers that he doesn’t have enough money to pay the bill. No problem. Just keep ordering more food! That way you can put off the moment of reckoning. That is not a practical solution for irresponsible customers or countries who have gone too far. Greece is in this boat. They may soon be joined by others. I hope the US gets on a different boat.
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