by Don Alexander, MBA
Associate, RSD Solutions Inc.
The Real Effect of Debt (Federal Reserve of Kansas City Jackson Hole Economic Policy Symposium, Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, Aug. 2011) Cecchetti et al, in a recent paper referenced below, looked at the debt levels and saw in moderate levels, it can improve welfare and enhance growth. However, high levels can have damaging effects.
The authors extend the work of Reinhart & Rogoff (2009) on government debt by including non-corporate and household debt. Based on estimations that include government, corporate and household debt from 1980 to 2010, the authors find that excessive debt levels can have a damaging impact on economic activity. The safe level for government debt is in a range of 80-100% of GDP. This was consistent with earlier studies, but the study was limited to advance countries and looked at data from the last 30 years.
The implication is that countries with high government debt levels must act quickly to address fiscal problems. Otherwise, these countries can experience a sustained period of stagnation. Long-term, a fiscal cushion is needed as a buffer for extraordinary events.
Similarly, the authors find that moderate levels of corporate and household debt can enhance economic prospects. The results suggest the threshold level for corporate debt is 90% of GDP and the level for household debt is 85% of GDP, although the result is less robust. Total debt levels in all three sectors have increased from 165% of GDP to 310% of GDP over the last 30 years. The most striking implication is that advanced countries are in worse shape than previously thought.
The problem is compounded by future promises made to the people, an aging workforce and slower population growth, and lower long-term economic growth prospects. As a result, debt rises faster, reinforcing its downward impact while raising the return demanded by investors. The authors, economists at the Bank for International Settlements, conclude that advanced countries need to act decisively to address fiscal problems before the adjustment costs become prohibitive.
Systemic risk will be elevated for the immediate future until the debt overhang is addressed.
For more information on this, follow the link: http://tinyurl.com/3lwhww2
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