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title: EPQ Essay

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(Bibliography https://hackmd.io/@winter123/reference)
Index 
# Introduction 
In European history, it is common for Kings to borrow money from merchants and banks. Sometimes, kings may fail to pay back their loans, or in other words, they commit obligation default, which usually brings serious consequences to their countries' economies.
(Douglass C. North & Robert Paul Thomas,5) In modern days, it is even more common for counties to borrow lots of money, and such defaults happen as often. 

Debt crises are situations in which a country is unable to pay back its government debt. A country can enter into a debt crisis when the tax revenues of its government are less than its expenditures for a prolonged period. (Terence Chan, 11). In another word, when the interest the borrowers need to pay outweighs the growth of income, debt crises are at risk, and when such interest rate exceeds the net income (total income - necessary spending), debt crises occur.(Ray Dalio,1,pg13) 

![](https://hackmd.io/_uploads/Hyn2_byR2.png)
> (IMF data,6)


Though some debt crises is caused by natual disasters or wars, a large percent of them is induced by financial mismangment. From the Graph above we can see that before the Covid-19 outbreak (2019), up to 19 countries are already in debt crises (Kristalina Georgieva, 6), and need support from the International Monetary Fund, an organization that provides emergency loans to countries that are experiencing balance of payments problems(IMF,7) while 37 more Low-Income countries are close to debt crises. 

However, if the problem does not go that worse, and both the central bank and the goverment make the right decitions, it is possible to prevent the country from actually falling into that criteria. 

This essay will first discuss about what happened before the debt crises and what mistake has been made, and then discuss what central bank and government can do to prevent or alleviate debt problem. 
# Methodology
(where data come from)
At first, the essay will use a variety of sources to describe the basic mechanism behind borrowing, interest rate, and debt. Using definitions and explaination from renowned textbooks and books, it is possible to use Term logic, or mathematical induction to suggest what kind of action, or data patterns, will lead to debt crises.

Then, to find out the typical pattern of debt crises, I take a few typical examples, like Latin America Debt Crises, Sri Lanka Debt Crises, and look deep into them. First, by reading essays and articals from scholar sites and historical record from FDIC and others, the essay shows what a debt crises looks like. Then collect datas like GDP, CPI, and Debt ratio from World Bank, International Money Fundation, government websites and United Nations, and analyze them so that the essay can divide a debt crises cycle into a few sepatarted parts and discuss what happen during each part.

For the third places, I search for news and reports from official websites and mainstream media like BBC, Reuters and DW reporting about what policy have been taken by governments to solve the problems, and their effectiveness. Combing with professional knowledge from Economy and Finance, the essay can show which policy can help and which cannot. 

Finally, the essay use a specific case, turkey, to put the analyze into real-life situations. First, find figures like exchange rate, foreign debt rate and GDP growth rate of turkey from its official website, and then using them to find the 'turning point' of Turkey's economy, which is analyzed in the second part of this essay. Then by looking at news from Turkey local media and international medias like CNN and The Washington post, find out what mistake they've made and why these mistakes let Turkey fall into debt crises. Finally, find what action has been taken by turkey government, and analyze their effetiveness. Also, the essay will also gives some suggestions to them.

# Why Do debt crises appear (1500)
## Why Do debt crises appear
Before and during the Middle Ages, people usually view charging interest from borrowers as something 'Immoral'. Though the main reason behind it is that the bible stated that, during that time, in most cases, people only borrow money when they encountered some emergencies, in other words, it is somehow immoral to charge interest from someone who was already in Trouble. However, in the Age of Discovery and afterward, people start to borrow money for investment, correspondingly, they start to use the money they earned from investment to pay lender interest. 

If a country borrows money for investment, like building useful infrastructures, schools, etc., they will be able to collect more tax as the development of the economy and pay back the loan. However, if the government does not spend money they borrowed on things that can increase tax revenues, or if they overesitimate the effectiveness of their investment, then they have to pay back the interest with future money. Speaking Mathmatically:

if : Annual Net Income (Total Income - maintainence fee) **<** Money invested * interest rate 

then such investment is 'not worthed' meaning government need to increase tax or borrowing more money to overcome this spending. 

Usually, the country that falls into a debt crises experience at least one of these situations:
1. Overborrowing and overspending, or overestimation of its debt repayment ability.
In most cases, government investment is about providing public goods, or goods like infrastructure that are  both non-excludable and non-rivalrous (Greg Mankiw, 2) and things that can bring high external benefits like education. Estimating how much benefit, or how much more tax can be collected after these investment is quite challenging. Even worse, economists often overestimate long-term economic growth, and encourge governments maintain a deficit budget.
2. Foreign Central bank massively hike interest rate
If the money used for investment is borrowed in terms of foreign currencies, then the base interest rate is determined by foreign central banks, and if they increase their interest rate, then the government have to use more foreign exchange reserve, or foreign currencies and gold held by central bank (Greg Mankiw, 2) to pay back these loan.
3. The price of raw material that are essencial to the country's industry rised rapidly.
If price of energy, metal, and food rise dramatically, and the country is a net importer of these goods, then such country's economy will probably go into a downturn known as Stagflation. Trade deficit will increase, inflation will went up, and since its cost-push inflation, the unemployment rate will remain high. This is especially bad for country that already has a high debt/GDP ratio as such Stagflation would greatly reduce the tax income. 
4. Natual disasters, Wars etc. greatly reduce its productive potential.
These crises just destory all the wealth and cannot be solved, so they will not be discussed in this essay. 

In general, though some unexpeted events are just unavoidable, the governments should not be too optimistic about its economy during fast-developing period, and leave some spare money, or some spare borrowing ability to deal with potential crises. However, as politicans usually care more about short-term interest, they frequently ignore what will happen in the next stage of the economy, not to say try to aviod it ,and that makes all debt crises similar and can be catogorized into 3 stages.
## Three Stages of Debt Crises
Typical, there are 3 basic stages for Debt crises, First: Borrowing and Spending a lot, Second: Struggling to pay back debt, Third: Successfully distributing or reconstructing the debt, Or debt default. By analyzing examples from Latin American Debt Crises, it is clear to see what is happening during each stage.

### 1. Borrow and spend a lot
After World War 2, it is noticeable that many countries experienced a period of fast development after getting peace and stability. Many LDC or less-developed countries, especially countries in Latin America, experienced high economic growth. For more than a decade before 1973, the growth rate in the real domestic product of the LDCs averaged about 6 percent annually. (Eliana Cardoso and Albert Fishlow,13). During such a period, governments usually decide to borrow money, and use that to build infrastructure or do other investments. Since these countries usually do not have enough infrastructure, doing so would bring this country higher efficiency and more investment, resulting in more tax being collected. Till now the national debt should' t be a problem as long as the income growth rate is faster than the debt growth rate. 

However, after some fast-developing period, the GDP growth rate of these countries would eventually fall, and investment will not be as profitable as before. On the other hand, both businesses and governments have high confidence, making them still willing to borrow a lot of money for investment. During such a period, a high percentage of demand in the economy comes from borrowing, leading to some kind of market bubble. In addition, the central bank usually further stimulates that by maintaining a lossy monetary policy, even further reducing the interest rate to keep the economy growing fast. 

Starting from 1970, international banks are expanding all over the world, and financial innovations, regulatory arbitrage, and competitions between banks lead to what's called the 'credit boom'. (Robert N McCauley, Patrick McGuire, and Philip Wooldridge 15) These all make big companies and governments in Latin America much easier to borrow money. Even worse, international banks' credit tends to grow faster than domestic credit, stimulating the financial imbalance and leaving borrowing countries with higher risk. (CGFS (2011); Borio et al (2011)). 

Though most developing countries have experienced fast economy growth, only a few of them goes into the second stage. The countries that fall into this rank usually have at least 2 of the following characters:

1. has a relatively high trade deficit, or the total value of import greatly exceeds that of export. 
A high trade deficit usually means 2 things. First, the country has a relatively low Foreign exchange reserve, or other countries' currencies, which makes it hard for this country to deal with the fluctuation of the global economy. Second, given it is a developing country, it also suggests that the country does not have strong industries.
2. highly rely on foreign goods and capital 
If the global interest rate or Federal Reserve and ECB decided to increase the interest rate by a great amount, then the global investment would be drawn out of this country. Even worse, as the country need these foreign currencies to import industrial or consumer necessities, it will make such a country very hard to borrow money and do so.
3. some sort of bubble appears, or stock price and/or house prices are much higher than average level while people borrowed a lot of money for buying a house or stock. 
Bubbles suggest 2 things. First, a high positive GDP gap appears, meaning the GDP growth rate will dramatically decrease when the economy faced some problems, even a small one. (Mr. Tamim Bayoumi, 16) Second, during bubble time, companies and families borrowed lots of money for buying stock or houses, and government may need to spend extra money on them to prevent them from going bankrupt and hurt the economy. 

Unfortunitly, Most Latin American countries back in 1980 has the following characteristic

![](https://hackmd.io/_uploads/S1aCT8j23.jpg)
> (Created using https://www.theglobaleconomy.com/compare-countries/)

From 1973 to 1978, most Latin American countries has a relatively high trade deficit. This is partly due to high oil price, but the fact that these country do not have strong and profitable industries also contribute to that factor. 

![](https://hackmd.io/_uploads/HyGov3o33.png)
> JEFFREY D. SACHS 17

![](https://hackmd.io/_uploads/SkEHunih2.png)
> Timothy Curry and William R. Watson 14

Moreover, as stated before, the growth of Latin American benefited a lot from expantion of international banks, that also let them heavyly rely on foreign capital 

As a result, the countries fall into the second stage.

### 2. Struggle to pay back debt

In second stage, a few things would happen: 
1. the benefit that can be gain from investment reduced greatly, even less than the interest rate.
If most investment are from internal, or in another word, most debt are internal debt, then this interest rate is set by this country's central bank, but if this country borrowed lots of money in terms of foreign currencies, then such interest rate is determined by foeign central banks.
2. The sovereign Credit rating may drop or become more negative, making it harder, or more expensive to borrow money.
Taking Moody as an example, their evaluation is evaluated on the basis of how they perform on a statistical basis ex post (e.g., default studies, accuracy ratios, and stability measures). (Moody, 18) When debt grow much faster than GDP growth, their rating will drop. However, it is noticeble that, low government expenditure dring economic downturn will further reduce the Aggregate Demand, causing even lower GDP growth and higher unemployment rate, and worsen the Credic rating as well.
3. Foreign and local investors reduce their investment scale, or even withdraw their investment. 
Since investing here is not as profitable, global investor will try to find places where investment is more profitable and invest there. Such action will reduce the country's forex reserve, as well as increasing trade deficit, making the country harder to pay foreign debt.

If these three become true, it is safe to say that this countries' economy is in danger, and any spark, including increase in energy prices or interest rate, natual disaster, etc. can result in a debt crises.
(something more may needed)

Finally, some simple measurements cannot save the economy and prevent sovereign default anymore, and some combination of measurements have to be taken to solve the problem. And that proceed to the Third Stage
 
### 3. Successfully distributed or reconstructed the debt Or debt default 

Though in both cases, the country will experience some economic downturn or depression, but clearly, the result is quite different. Debt default often result in high inflation, massive decrease in GDP, even hunger and child labour (Ishara Danasekara & Tom Donkin, 19) But if this country is **lucky** enough to avoid that, this country still have the posibility of becoming a developed country. 

Solving the problem requires:
1. The problem itself is not that serious.
2. Right Actions being taken by Government and Central bank
3. Internal political unification, or businesses and people are united under a adequate and efficent government to deal with crises.
4. Global financial support (for external debt)

Therefore, governments need to plan very carefully about what they need to do, which is discussed in the next following chapter.

# What governments can do to alleviate the problems
Generally speaking, there are 2 kinds of debt, internal debt, and external debt. The methods for dealing with each kind of debt are different from the others, so it is reasonable to solve them one by one. 

However, 
## How To solve internal debt
Though the definition of internal debt, or domestic debt varies from country to country (World Bank, 9), it usually has 2 characteristics: borrowed from domestic investors and accounted for in terms of local currency. 

Though many developing countries' public debt consisted large proportion of external debt before 2008, it is noticeable that many of these countries are now trying to build their debt markets and borrow more money from them. (World Bank, 9)

In most cases, internal debt is not a big problem, since the central bank of such a nation can fully control the interest rate of these debts, or even print out some money to buy back these debt, which is known as Quantitative Easing. It's not hard to use a mathematical model to simulate such a situation.

Such a model can only be applied to countries with the following characteristics:
First: Know how much internal debt it owned. Only 66% out of 70 surveyed low and middle-income countries can record basic statistics about how much debt they owned (World Bank, 9), And that includes the PRC (Laura He, 10)(Christine Ip, 11) In fact, Governments like PRC like to use State-owned Enterprises (SOEs), state or local governments, 'financing platforms'(Laura He, 10)(Private companies that help governments borrow money), etc. as a way of rising capitals, as these actions can make the balance sheets of Central governments look better. Nevertheless, the central government should at least calculate how much debt it owned. 
Second: The majority of the public debt is internal debt, as stated before.

Variable: 
NI: Net Income, or total income - necessary expenditure(do not include interest payment)
I: Interest rate, assume that 1. all debt has the same interest rate 2. central banks' base interest rate = internal debt's interest rate (In the real world, methods like Yield Curve Control(YCC) might be implemented)
D: Debt that needs to pay interest
i: Inflation, assume that the net income grows with inflation

First, if NI > I x 


## How to solve external debt
External debt is debt borrowed from entities from other counties and is counted in foreign currency. Debt like this is much harder to deal with because First, the country itself cannot control the interest rate of such currency, Second, a debt like this can only be paid back using Foreign exchange reserves, or in other words, net export.
### What action should be taken
1. Do not make internal monetary policy to contractionary

Monetary policy, is the policies set by central bank that can control the money supply of a economy (more definition) (Greg Mankiw, 2) can affect the interest rate of the economy. Contractionary moneytary policy means that 

Though, in most cases, inflation rate are high during the debt crises due to lack of supply, increasing interest rate could not help increasing supply and eliminate the inflation. On the other hand, high interest rate will makes companies that has a high debt ratio go bankrupt and prevent new investment. 

2. Impose tariff, or import tax, on unnecessary consumer goods.
As stated before, most countries that fall into a debt crises have high trade deficit and high external debt. By imposing tariff on consumer goods, it could both generate foreign exchange to pay back debt, and reduce trade deficit. 

3. Prevent huge fluctuation of exchange rate and stock prices using reserved money and try to stop panic from spreading 

Though not much crises is caused primarly by Run on Deposits, it is undenyable that Bank run will dramatically deteriorate the problem. 

4. Avoid printing money and send them directly to governments. 

If people knows that their 

### What action will not solve the problems, even worsen them?
#### 1. using Foreign exchange reserves to 'protect' exchange rate. 
If most debt is foreign debt and such a country is at risk of sovereign default, the credit rating for such a country will fall. Thus, investors and savers in that country are more willing to exchange their currency for foreign, more trustworthy currencies, causing devaluation of the exchange rate. Usually, central banks will try to prevent local currency from devaluating by buying local currencies using foreign exchange reserves or using other monetary methods. However, these may cause the following problems:
1. Encourage money from flowing out of the local market 
A stronger exchange rate can let people even more willing to sell their local currencies and buy US dollars.
2. lose of valuable forex reserve 
This money should be used to pay back debt or other more useful ways. Protecting exchange rate is like giving out money to rich people within the country
3. Discourage export and encourage import
This will lead to further loss of forex reserve and are harmful to the economy
4. Actual protection result is usually bad
#### 2. Stop the importation of certain goods or raw materials. 
Though sometimes, governments may try to stop trade deficit with any means in order to prevent foreign debt default, they should not try to ban importation as stop importation may result in :
1. Production of Certain good being stopped or slowed down.
For example, In November 2021, Sri Lanka ban all chemical fertilisers (Uditha Jayasinghe and Devjyot Ghoshal, 28) Though President Gotabaya Rajapaksa chaims that such move aimed at protecting the environment, but most people believe that he just want to reduce trade deficit as Sri Lanka import most chemical fertilisers from other countries. Nevertheless the result is clear, such policy lead to an annual drop of at least 30% in paddy yields nationwide, and throw Sri Lanka into debt default and hunger. 
2. People, expecially rich people leaving the country
Some "luxuries" might be necessities for rich people, and if they cannot by these good in their own countries, they'll try to emigrate into other countries.
# Turkry Case Study (800)
## Background and Overview
Turkey, officially the Republic of Türkiye, is now the 19th largest economy in the world and a member of G20. Since some historical reasons, turkey is part of European Union Customs Union (EUCU) and NATO, making it has more access to Western market and capital than most developing countries. Moreover, the current president, Erdogan, has stayed in the highest position of Turkey for over 20 years. Though being criticise as a dictator, Erdogan does bring this multiracial country with high political stability and the political power to get something done. These 2 factors gives Turkey the possibility of solving debt crises and can be a perfect example for studying debt crises.

The Turkish economy has achieved an outstanding performance with its steady growth over the last 15 years. (Adam Samson, 21) 

![](https://hackmd.io/_uploads/rkz9f8eR2.png) (27)


However that is achieved by borrowing foreign debt
![](https://hackmd.io/_uploads/HyhFIgR2n.png)
As a result, the fast development of turkey economy stopped at the end of 2018, when a currency crises appear.
![Adapted from XE](https://hackmd.io/_uploads/HkT6uQ062.png)


## Timeline of Turkey debt crises
### Fast-developing period (Stage 1 : 2003-2017)
During and after World War 2, Turkey made the right decition of trying to keep good relationship with the Western, Democratic world, and that bring turkey with peaceful environment and investment from developed countries. Since Turkey consider itself as a European country, it joined EUCU in 1995 and get EU candidate membership in 1999. With these help, Turkey start to develop in a fast speed since 2003.

However, the fact that companies and government of Turkey can easily borrow money from International banks also somehow encorge them to borrow too much. 

### In Risk of Debt Crises (Stage 2 : 2018 - 2021)

![](https://hackmd.io/_uploads/S1Avwx02h.png)




Now Turkey is in Stage 3, ans some they take actions to prevent Things from getting worse

## Actions that has been taken by Turkish governments

### Unorthodox Monetary policy 
![](https://hackmd.io/_uploads/H1TyOxChn.png)


# Conclusion (300)

This Reseach is aimed to find out the basic mechanism behind typical debt crises, and to give solutions to countires that already owed lots of debt, and prevent them going debt default.
