Monday, October 22, 2012

How To Escape From Consequences Of Private Credit Boom and Bust

Several of the worlds economies are suffering from the consequences of a private credit boom and bust.  The private sector is forced to make payments against its debt burden instead of spending on consumption and investment.  That is how balance sheet recessions lead to declining, or weak growth in aggregate demand.  In this article, Martin Wolf makes the case for government to increase its level of spending to compensate for the decline in private spending.  This increases the level of government debt, but the distribution of debt has been altered.  It has been transferred from the private sector to government.  Governments with their own currency, and the ability to borrow at low interest rates, have an option that is not available to governments without those advantages. He suggests that this is the least painful alternative for escaping from the consequences of private debt overhang.

Some have argued that recoveries from balance sheet recessions take a long time, and that recoveries can be lengthened, when government debt as a percent of GDP exceeds 90%.  Martin Wolf respects this line of historical research but he offers a defense for his policies, under the right context.  He also reminds us that the researchers who drew the debt to GDP ratio at 90%,  did not intend that it be used as an inflexible rule under all circumstances.

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