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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

07 September 2010

Private sector deleveraging

In my last entry I wrote about the debt reduction imperative confronting governments and how this deleveraging need not harm economic growth. What I did not address was the need for the private sector to deleverage as well. The Bank for International Settlements (BIS) has devoted a chapter in its latest Quarterly Review (here) on private sector deleveraging, which contains valuable insights and builds on the argument I made. 

First, the BIS shows there is a significant reduction in non-government debt after a crisis where credit was booming. In fact, “on average, private sector credit over GDP increased by 44 percentage points before the crisis, followed by a drop of almost the same magnitude (38 percentage points).” So countries end up with a similar private-sector debt level after the crisis as they had before the credit expansion took place. 

Second, the debt reduction path was driven equally by GDP growth, inflation and lower credit, meaning that the debt was not inflated away but there was either GDP growth that was faster than new borrowing or there was an outright reduction in debt (the BIS says that it cannot distinguish between paying off or defaulting on debt based on the data it has.) This is important since markets are jittery that high debt ratios will produce inflation – although governments can inflate away debt more easily than the private sector if they have the help of a central bank. 

Third, the BIS argues that debt reduction is compatible with economic growth, even though its evidence for this is not quite apparent in the paper; what it says is, “A possible concern is that a sustained period of debt reduction might lead to low growth in the future. Our analysis casts doubt on this. Growth rebounds rather quickly in most of our episodes, even though debt ratios continue to fall.” 

The one aspect that the BIS does not explore is what happens when deleveraging needs to take place in both the public and the private sector at the same time. In that case, a country can only resort to exports or savings-financed private investment for growth. And while the latter can be generated internally, the former depends on others sustaining demand, which makes collective deleveraging more difficult. And while this stands as the main caveat to take away to investigate further from the BIS study, I am still heartened by the results presented here.

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1 Comments:

Blogger MR said...

Hi

Just found your blogs. Are you stkll active?

6:41 PM  

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