Free Lunch: The fear of debt

Δημοσιεύθηκε: 21 Απριλίου 2015 - 11:14

Debt, debt everywhere

The defining rhetoric of the UK general election is based on the fear of debt. So successful has the coalition government been at making fiscal retrenchment the mark of economic responsibility that Labour is having a good stab at looking fiscally more responsible than the Tories. Debt aversion also shaped politics in the US until recently, and still very much does so in the eurozone. So let's bamboozle-proof our understanding of why and how debt matters for the economy.

Start with a plain fact that is obscured by lazy talk of "the nation's debt". A government shrinking its deficit and paying back its debt does not necessarily mean that a national economy lives more within its means or becomes less indebted. This should be particularly clear in the UK. The government debt reduction promised in the March Budget will come on the back of greater debt in the household sector. Much higher, in fact:

That graph, from the Office for Budget Responsibility, shows household indebtedness as a proportion of income rising to higher levels than before the crash.

Then there is the economy's foreign borrowing. Far from a country living within its means, the UK's current account deficit has widened dramatically in the past few years:

That's partly because the trade deficit remains stubbornly large (so much for the benefit of your own exchange rate), but even more because UK investments abroad have started to yield much poorer returns than foreigners' investments in Britain. The OBR expects the trade balance to improve and the income deterioration to reverse. But even on those rosy assumptions, the gap between how much Britain spends and how much it produces will remain larger than the average in the decade before the coalition's supposed belt-tightening. All that's happened is that debts and deficits are moved from the public to the private sector.

And the UK is not the only place where private debt accumulation has continued apace even as governments make efforts to tighten their fiscal belts. Adair Turner and Susan Lund find that of a $57tn increase in gross global debt since 2008, more than half has been contracted by private borrowers. Stephen Cecchetti and Kermit Schoenholtz write that non-financial corporate debt is more than 100 per cent of GDP in a number of eurozone states, including some firmly part of the "core" European economy.

So what? There are two answers to that. First, if you really think high debt is problematic, focusing exclusively on the public sector is to sweep the dirt under the carpet. Second, debt - private debt - is in fact problematic. Since creditors are likely to consume less of their income than debtors (that's how you get to be a creditor in the first place), high debt weighs on aggregate demand, which is the last thing the rich world needs at the moment. And when debts are big enough, the uncertainty around how and whether they will be repaid can itself act as a brake on economic activity.

Of course, as long as a debt bubble is inflating it can fuel demand, but that stores up problems for when the crash eventually comes. This should be obvious after the 2008 financial crisis. Our detailed understanding of that debt bubble and bust continues to improve, and FTAlphaville's Matthew Klein has just written an excellent guide to some of the latest US research. He rehearses what has already been established, which is that the areas with the greatest increase in debt before the crisis saw the biggest drops in house prices afterwards, and as a result the biggest contraction in local economic activity. A new paper has found that corporate indebtedness played a crucial role in these contractions. Businesses that had accrued debt before the crisis disproportionately responded to wilting demand by laying off workers and cutting back output. That, of course, made the household debt crisis worse. Consumer and business indebtedness came together in a vicious downward spiral.

What to do about this? Both Turner/Lund and Cecchetti/Schoenholtz dutifully rehearse the politically kosher solutions of countercyclical regulation and boosting productivity to make large debts payable. But, to their credit, they quickly move on to the reality that more radical measures are needed to eliminate existing debt overhangs and avoid future ones. One such measure is to write down debts outright (or erode them through higher inflation). Debt restructuring is fortunately gaining support at the top of the economics establishment. Prominent European economists are calling for a "new start" for the eurozone by writing down official debt. The IMFdirect blog argues that private debt restructuring is desirable when mortgage debts are too high.

Better, of course, if you can ensure it never gets to that. Turner/Lund mention the promise of encouraging more equity-based finance. Robert Shiller has famously advocated private mortgages with built-in restructuring options. In the UK, the Mirrlees Review proposed an end to tax discrimination in favour of corporate debt to the detriment of equity. These are the sort of measures we should expect from politicians who claim to understand the dangers of debt.