Greater inequality and household borrowing? New evidence from household data
Olivier Coibion, Yuriy Gorodnichenko, Marianna Kudlyak, John Mondragon 29 January 2014
One popular explanation for the increase in US household debt in the years before the subprime mortgage crisis is that households with stagnating incomes borrowed more to ‘keep up with the Joneses’. This column presents recent research that questions this explanation. Low-income households in high-inequality regions in fact borrowed relatively little compared to similar households in low-inequality regions. A theoretical model in which greater local income inequality facilitates the screening of loan applicants makes predictions that are consistent with the data.
The financial crisis of 2008–09 was preceded by an exceptional rise in borrowing by US households, accounted for primarily by a rise in mortgage debt. There are two main views about the source of this ‘great leveraging’:
- The rise in borrowing reflected ‘credit supply’ factors.
Proponents point to progress in information technology (Sanchez 2009) and rising financialisation of debt (especially mortgages) as increasing the supply of credit, particularly to low-income and high-risk households (Drozd and Serrano-Padial 2013).
Financial markets Poverty and income inequality
US, Inequality, debt, credit rationing, subprime mortgage crisis
Catenarian fiscal discipline
Hans Gersbach 04 January 2014
Democratic governments tend to accumulate excessive debt. This column proposes a new rule – the ‘Catenarian Fiscal Discipline’ – which allows a fiscally disciplined incumbent to limit the debt-making of the next officeholder. This way, fiscal discipline today can lead to fiscal discipline in the future. Such a rule would require that we broaden our notion of representative democracy by recognising the fact that a current government already has various implicit ways of limiting what its elected successors can do.
Limiting the accumulation of public debt in democracies has always been a problem, but it has become a particularly pressing one in the last few decades. While there are normative justifications for public debt-making – such as letting automatic stabilisers and tax-smoothing measures operate (Barro 1979) – political processes tend to push public debt to levels that are likely to be socially undesirable.
democracy, fiscal policy, debt, time inconsistency, fiscal discipline
Public debt and economic growth: There is no ‘tipping point’
Markus Eberhardt, Andrea F Presbitero 17 November 2013
The idea that there is a common tipping point in the relationship between public debt and economic growth is still widespread. However, this is likely due to a misinterpretation of the existing evidence. Once we allow for the relationship between debt and growth to be country-specific, there is limited evidence supporting the presence of a within-countries debt threshold.
The presence of a common threshold, or ‘tipping point’ – beyond which the detrimental impact of debt on growth is significant, or significantly increases – is currently taken as given in many policy circles. In the US, although many political battles impinge on the Congressional debate over the debt ceiling and the resulting government shutdown of October 2013, this somewhat reflected a widespread belief that debt is dangerous, and that fiscal austerity represents the only way of restoring sustainable growth.
growth, debt, austerity
The Scottish question
Angus Armstrong, Monique Ebell 26 October 2013
In the debate over Scottish independence, the question of how the UK’s assets and sovereign debt would be divided has received insufficient attention. This column argues that the size of Scotland’s debt obligations would be crucial to its optimal choice of currency. Under plausible assumptions, fiscal tightening would be required to return Scottish debt to sustainable levels, and a self-fulfilling rise in borrowing costs might tempt Scotland to leave the sterling currency union. A debt-for-oil swap might be mutually beneficial for a newly independent Scotland and the continuing UK.
In less than one year, on 18 September 2014, the Scottish electorate will vote on a question of historic significance – should Scotland remain in the UK, or should it become an independent country?
But what would an independent Scotland look like? We think that one important question that has not received nearly enough attention is debt. How will the existing UK government debt be divided between an independent Scotland and the continuing UK – assuming the remaining home nations constitute the continuing UK (Tierney 2013)?
Europe's nations and regions Macroeconomic policy
independence, debt, Currency unions, Scotland, sterling
Sovereigns versus banks: Crises, causes and consequences
Òscar Jordà, Moritz Schularick, Alan Taylor 18 October 2013
In the aftermath of the global financial crisis, few would dispute the risks of excessive borrowing. But which debts should one worry about – public or private? This column presents new research on the interplay of public and private debts since 1870 in 17 advanced economies. History demonstrates that excessive private-sector borrowing plays a greater role than fiscal profligacy in generating financial instability. However, when the credit boom collapses, the government’s capacity to alleviate the downturn is limited by the prevailing level of public debt.
Some observers – often with great conviction – see the European crisis through the lens of public finance (Alessandrini et al. 2012). They see the key source of the problem as the inherent inability of past governments (many in the periphery, and possibly soon even some in the core) to live within their means. For these observers, stricter fiscal rules – a ‘better Maastricht’ – are what would have saved the day, and what will now be required to prevent another crisis down the road.
Economic history Financial markets Macroeconomic policy
financial crises, business cycles, debt, fiscal space
The IMF and the legacy of the euro crisis
Susan Schadler 15 October 2013
The IMF loans to Greece, Ireland and Portugal are considered controversial by some analysts. This column argues that these loans – granted without having agreed on convincing paths to manageable debt levels – constituted a substantial departure from IMF principles. The situation is costly for Europe and, having now permanently changed the principles guiding large IMF loans, it will be costly for crises to come. A serious rethink of the management and decision-making structure of the IMF is needed.
The IMF will live with the legacy of its role in the European debt crisis for years — if not decades.
Global governance International finance
IMF, debt, EZ crisis
Enhancing the global financial safety net through central-bank cooperation
Edwin M. Truman 10 September 2013
Should we expect more global financial crises? This column argues that we should. Global financial crises are far from being a thing of the past because they are often caused by buildups of excessive domestic and foreign debt. To successfully address them and to limit negative spillovers, we need coordinated actions that prevent a contraction in global liquidity. Unless we establish this more robust, coordinated global financial safety net centred on central banks (which is where the money is), we may end up being incapable of addressing inevitable future crises.
The prospect that the Federal Reserve will soon ease off on its purchases of long-term assets has increased financial-market uncertainty and contributed to a retrenchment in global capital flows. This turbulence has revived discussion of the need to enhance the global financial safety net –i.e. the set of arrangements to provide international liquidity to countries facing sharp reversals in capital inflows despite following sound economic and financial policies.1
The dominant lessons from the financial crises of the past decade are:
Global crisis International finance
Central Banks, liquidity, banking, debt
External liabilities and crisis risk
Luis AV Catão, Gian Maria Milesi-Ferretti 04 September 2013
Debt seems to be a lightning rod for crises. This column presents new research showing that the ratio of net foreign liabilities to GDP, and in particular its net external debt component, is indeed a significant crisis predictor for both advanced economies and emerging markets. Large current-account deficits and real exchange rate appreciation – the standard predictors – still matter, but we should be thinking more about net external debt.
Much has been written about the causes of the global financial crisis of 2008 – the role of the US subprime crisis as a triggering event, the generalised period of easy credit and financial excesses fuelling growing economic and financial vulnerabilities, the failures to properly regulate large systemic financial institutions. Nevertheless, our understanding of the intensity with which the crisis has affected different countries remains modest (Rose and Spiegel 2009, 2011).
debt, Eurozone crisis, net external debt, liabilities
Eurobonds: The design is crucial
Roel Beetsma, Konstantinos Mavromatis 21 December 2012
Are Eurobonds a desirable solution to Eurozone members’ debt crises? Unhappily, it’s difficult to say. This column argues it very much depends on how the system is designed. However, looking at the most prominent proposals, it seems a cleverly designed Eurobonds system may well provide governments with the right incentives to encourage both issuing less debt and pursuing meaningful structural reform.
The debt crisis in Eurozone southern states has given rise to a number of measures to strengthen fiscal governance in Europe. It has also sped up plans for further integration of policymaking in the Eurozone. The European Council (2012) envisages the transition to a genuine economic and monetary union being based on four building blocks: an integrated financial framework (a ‘banking union’); an integrated budgetary framework; an integrated economic policy framework and measures to ensure the democratic legitimacy; and accountability of decision-making in the EMU.
debt, Eurozone crisis, debt restructuring, eurobonds
Solving the macroeconomic policy challenge in Europe
Richard Wood 19 December 2012
Five years after the subprime bubble burst, the self-correcting nature of business cycles is being questioned and, subsequently, orthodox macroeconomic policy is starting to be challenged. This column introduces a radical rethink of options open to macroeconomic policymakers, suggesting that in order to simultaneously achieve economic stimulus without increasing debt, new money creation should be used to directly finance on-going budget deficits.
Countries in Europe are either slipping into recession or experiencing worsening depression. Economies are headed in the wrong direction, and the malaise is spreading. The current orthodoxies are failing.
Subprime, debt, macroeconomic policy, quantitative easing