In the decade since the financial crisis, the major economies have experienced a prolonged period of low inflation. Policy interest rates in several economies remained at or close to the zero lower bound. Debt has increased over the past decade, at a time when policy interest rates remained very low, creating potential vulnerabilities.
Recent increase in private sector debt across advanced and emerging economies has raised public sector debt further and created a vulnerability to interest rate shocks. This Jubilee post looks at policy issues arising from the increased debt.
The financial crisis caused by the Covid pandemic and the measures taken to combat it have created a severe cashflow shock to companies, raising issues about the availability of funds for re-financing, and an income shock to households.
Recent Increases in Debt
The financial stability of the advanced economies is being put under strain by increasing debt, with emerging market economies having a much higher debt burden than the advanced ones. What are your thoughts on this?
The record $129 trillion for advanced economies is 272% of GDP, which is slightly down on the record debt to GDP level reached in late 2016. Whichever way one looks at it, debt in the advanced economies is higher. There’s a similar position for emerging companies, where the level of indebtedness has increased from 92% of GDP to over 140% also the gap between debt and GDP ratio has decreased substantially.
The overall figures for indebtedness of the public sector, household and non-financial companies in major advanced and emerging economies show a rising trend of debt in all three sectors.
The rise in debt by non-financial companies in the emerging economies has been more substantial than in the advanced economies but the debt to GDP ratios of non-financial companies in these countries are still lower than in the advanced countries.
The interest rates that the governments of many countries are now paying on debt are at historically low levels as a result of the long downward drift in global real interest rates and the monetary policy responses in the financial crisis and afterwards.
Private Sector Debt and Current Trends
Most household sector debt to GDP ratios have fallen in some major economies since the financial crisis, supported by interest rates running at historically low levels and the expectation of income growth continuing.
The much higher debt levels are supported by ultra-low interest rates which may prove to be temporary and mortgage rate stress tests are applied to try to ensure that new debt could still be serviced if interest rates were to rise.
The economic crisis has led to a rise in debt and a decline in future income prospects. The impact of the crisis on debt service is likely to have a knock-on effect on future income.
The rise in corporate debt in China and the US has been cited as a potential cause for concern to financial stability in emerging market economies. How do these issues relate to each other?
The shock from the coronavirus outbreak has had major effects on companies around the world and the combination of high corporate debt and reduced cashflow threatens to increase defaults and job redundancies. What can be done?
Issues Arising from the Continued Increase in Debt
The policies of low interest rates and elevated debt over the past decade have necessitated a shift in economic policy.
The adverse impact of the coronavirus outbreak on household and corporate debt levels could lead to a wave of defaults and a prolonged period of slower growth in the subsequent economic recovery phase.
Macroprudential policy tools have been used to help banks maintain the supply of credit to companies in the current financial crisis. Is macroprudential policy a useful tool to help prevent or resolve asset price bubbles?
The rise in non-financial company debt in emerging economies is a signal about future economic performance. The IMF has recently noted that balance sheet vulnerabilities in nonfinancial companies and in nonbank financial entities are elevated by historical standards.
Government Policy Focus on Debt and Coronavirus
Governments around the world are focusing on debt and the coronavirus. The rise in debt in the private sector has been brought into prominence by the effects of the coronavirus and the various policies introduced to support the economic activity of households and companies.
The May National Institute Economic Review estimated that government debt to GDP ratios in the major advanced economies would increase by around 10 to 15 percentage points as a consequence.
The increase in private sector debt from an already elevated level could pose policy dilemmas for governments once the immediate health crisis is over. There have of course been many plenty of previous finanicial crisis, in many espects the Asian crisis in 1997 reminds me, yet the pandemic background makes this truly unique. How will the economy perform once the lockdowns are lifted?
How might governments provide guidance to lenders on forbearance, extend loan repayment periods, or provide guidance to lenders on permissible extensions of loan repayment periods?
The severe fall in economic activity may lead to measures such as debt write-downs or bail-outs to prevent or limit company failures. Governments will have to carefully weigh the arguments for support, with the associated job losses.
The pandemic and its impact on health and economic stability will require international support for countries in difficulty. Macroprudential policy will be key in dealing with the pandemic.