Should central banks boost the world economy by writing off part of the government debt they hold? Trimming debt in this way might have economic and social consequences, but it could be an experiment worth trying

The most notable thing about the latest stage in the Greek debt crisis, and the delay to the bailout decision, was the further write down of debt. The so-called ‘haircuts’ continue. But even this significant ‘trim’ was not enough to bring Greece back to the party.

If Greek investors could be pushed into the barbers, will bigger heads follow? What about President Obama having a head shave as he jumps over the US's fiscal cliff?

Are we at a tipping point in finding a radical approach to revitalising the world economy by writing off debt?  The major post-crisis governments of America and the west have failed to reduce their debts via inflationary growth. At the current rate of change, running an implicit policy of financial repression (where inflation is higher than interest payable) will take decades to impact on positive growth.

It has also proved impossible to find a way back through austerity measures.  Cuts further reduce activity and growth. There is a growing realisation from all sides that none of this is working.

Instead of our leaders wearing sackcloth and ashes to their G8 Christmas parties, new haircuts may be more fashionable.  With monetary policy post Quantitative Easing having no effect (there is a natural limit to how much more domestic debt the US and UK governments can exchange for new cash) the question to be debated is: can central banks write off much of the government debt that they have now purchased?

Is it possible to ‘vaporise’ such debts into thin air without economic and social consequences? No one really knows. But maybe it is an experiment worth trying – with fewer negative outcomes than we might imagine?

Before the crisis the major international commercial and investment banks created ‘money from nothing’ and blew up monetary bubbles that burst, only to see the scattered shreds of waste picked up by central banks and governments.  Can much of that money depart the same way it came?

We are living in unchartered waters.  The first model of unconventional monetary policy (Quantitative Easing) doesn’t work anymore. Some predicted QE would lead to rampant inflation. It didn’t. In the UK, a Bank of England report suggested at most it added a few percentage points to UK prices.

QE is just ‘propping up’ large financial institutions and commodity, equity and asset prices and keeping interest rates manageable for low-risk and long-term borrowers. Most cannot borrow anyway.

The next stage of unconventional monetary policy is beginning to be imagined. But those dreaming about Model 2 are unsure if it is the first act in a nightmare.  Lord Turner, a candidate for the recent central bank governor’s job in London, was ahead of his time when he recently suggested that the Bank of England write off billions of pounds of the debt it holds in Treasury bonds thereby improving the public finances.

Maybe this radicalism cost him the top job at the Bank, but shortly after his suggestion the UK Chancellor, George Osborne, took one step on that policy road. He agreed that the UK Treasury would not pay the Bank several billion in Gilt coupons this financial year. UK bond prices hardly moved.

Osborne put his finger in the fire and it did not get burned. With corporate tax receipts and deficit reduction going down the plughole, more Treasury debt write off might be a risk worth taking to get re-elected.

What might go wrong with head shaves?  The biggest devaluations of major currencies that we have ever seen?  Spectacular sell offs on the world bond markets?

Clearly central banks writing off government debt will only proceed at a slow pace, so there is a chance to see the impact.  It might end in tears, but it might not.  Courageous decisions and new policy types are required. We need a radical policy model for a new era in history, and we hope and pray that when it comes it will work.

Philip Haynes is professor of public policy at the University of Brighton and the author of Public Policy beyond the Financial Crisis: An International Comparative Study