Any hope of recovery in advanced economies should perhaps end with this research paper..

I have not blogged about the papers presented at Jackson Hole Conference – 2011 which is bad.

This paper by Stephen Cecchetti, Madhusudan Mohanty and Fabrizio Zampolli is a must read. It looks at debt levels in all 3 sectors of economy – households, public and private- of various advanced economies. They also look at threshold levels of debt for each of these sectors to understand when high debt starts impacting growth.

Their findings:

  • For government debt, the threshold is around 85% of GDP.
  • When corporate debt goes beyond 90% of GDP, it becomes a drag on growth.
  • And for household debt, we report a threshold around 85% of GDP, although the impact is very imprecisely estimated.
And then you check the tables at the end of the paper. There is a nice table (in xls) which gives all the data as well.
There are debt levels for all select 18 economies in each of these sectors. The median debt of these economies in all three sectors is much over the threshold levels. There are inter-economy differences like US has a low corporate debt, Japan has a lower household debt, Germany has lower household and corporate debt etc.
But overall averages across are pretty large and every economy has atleast one sector which is highly indebted. Median HH debt is 94% of GDP, Pvt debt is 126% of GDP and Govt is 97% of GDP.
The authors conclude that ageing complicates problems further:

A clear implication of these results is that the debt problems facing advanced economies are even worse than we thought. Given the benefits that governments have promised to their populations, ageing will sharply raise public debt to much higher levels in the next few decades. At the same time, ageing may reduce future growth and may also raise interest rates, further undermining debt sustainability. So, as public debt rises and populations age, growth will fall. As growth falls, debt rises even more, reinforcing the downward impact on an already low growth rate. The only possible conclusion is that advanced countries with high debt must act quickly and decisively to address their looming fiscal problems. The longer they wait, the bigger the negative impact will be on growth, and the harder it will be to adjust. 

It is going to be really tough for these economies to come out with this hole.

It is this catch- 22  situation for them. If they push for fiscal consolidation/austerity now to show their intent to lower debt over long term, they are looking at aggravating the problems of slow growth further. If they maintain easy policies and go for a short term stimulus to push growth, they ruin chances of showing that they are serious in fiscal consolidation.  Like Lagarde says in the same conference:

Put simply, while fiscal consolidation remains an imperative, macroeconomic policies must support growth. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery. The precise path is different for each country. But to meet the credibility test, each country needs a dual focus: a primary emphasis on durable measures that will deliver savings tomorrow which, in turn, will help to create as much space as possible for supporting growth today—at least by permitting a slower pace of consolidation where possible. For instance—measures that change the rate of growth of entitlements, health or retirement.

This is desired, but so difficult to implement in practice.

And then you add HH and private sector debt and you are in for a triple whammy. What does government do to lower these two debt levels?

Hence the title of the post – I think we can just stop thinking about some fast recovery from current state of things. Even if there are some green shoots in future, they are likely to be short-lived. Deleveraging from all three sectors is a mighty task and would take time. It requites years of high growth coupled with loads of good luck. They messed up before crisis in boom times and just piled on debt. And now to reduce debt in such trying times is going to make everything all the more trying….


One Response to “Any hope of recovery in advanced economies should perhaps end with this research paper..”

  1. Jagadish vedaga Says:

    Please send me all eco book copy

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