A research paper supports the idea of debt forgiveness

If you’re like me, you’ve certainly wondered why economic growth has been so sluggish after the worst post-war recession — the Great Recession, or Great Financial Crisis as some have callednthe 2007-2009 crisis. Normally, the economy should have surged, after such a deep slump.

Instead, we’re proud of economic growth figures around 2% in Britain and the US and cheer when the eurozone posts a meager GDP advance of above 1% almost a decade after the crisis.

A paper published recently by the Bank for International Settlements (BIS) under the headline “The real effects of household debt in the short and long run” sheds some light on a topic that I have discussed several times here at Marketmoving.info: that of debt forgiveness.

Two years ago, I published an interview with Dr. Johnna Montgomerie, lecturer in economics at the Political Economy Research Centre (PERC), Goldsmiths University of London, in which she argued that for the economy to grow at a healthy pace, households in the UK needed a bailout, just as the banks received one.

The BIS paper shows that household debt, while boosting consumption and GDP growth over the short run (mostly within a year), proves to be a drag on economic growth over the long term.

The BIS researchers used data on 54 economies over the period 1990-2015, 23 of these being advanced economies and 31 being emerging markets. They measured loans extended by banks for the purchase of housing and other assets, such as cars, as well as unsecured debt, like credit card and student debt.

Their research showed that the long-run negative consequences of rising debt eventually outweigh the positive effects over the short term. They estimated that an increase of one percentage point in the household debt-to-GDP ratio tends to lower output growth by 0.1 percentage point in the long run.

As the household debt-to-GDP ratio exceeds 60%, household debt intensifies, they found. The negative effects of debt intensify as the ratio exceeds 80%.

What is worrying is that, far from falling after the Great Financial Crisis, debt has risen. Here is what the authors of the BIS say:

“Not only has deleveraging in the advanced economy (AE) household sector not proceeded as swiftly as expected but household indebtedness has also risen rapidly in many emerging market economies (EMEs) where they had remained modest in the previous decades.

Second, despite record low interest rates, private spending has remained weak globally and recovery illusive, even a decade after the burst of the US housing bubble.”

Policymakers will have to become more innovative to deal with this problem. It is why most major economies run a financially repressive system with real negative interest rates. But it seems this is not enough: straightforward debt forgiveness might be the answer. The sooner this is acknowledged, the better.