Tuesday, June 12, 2012

Where the Supply Side does not matter

The Rex Nutting post links to The real effects of debt, a 34-page PDF by Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli. Just a brief look:

At moderate levels, debt improves welfare and enhances growth. But high levels can be damaging. When does debt go from good to bad? We address this question using a new dataset that includes the level of government, non-financial corporate and household debt in 18 OECD countries from 1980 to 2010. Our results support the view that, beyond a certain level, debt is a drag on growth.

Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is used imprudently and in excess, the result can be disaster. For individual households and firms, overborrowing leads to bankruptcy and financial ruin. For a country, too much debt impairs the government’s ability to deliver essential services to its citizens.

High and rising debt is a source of justifiable concern. We have seen this recently, as first private and now public debt have been at the centre of the crisis that began four years ago.

Data bear out these concerns – and suggest a need to look comprehensively at all forms of non-financial debt: household and corporate, as well as government. Over the past 30 years, summing these three sectors together, the ratio of debt to GDP in advanced economies has risen relentlessly from 167% in 1980 to 314% today, or by an average of more than 5 percentage points of GDP per year over the last three decades.

When debt ratios rise beyond a certain level, financial crises become both more likely and more severe (Reinhart and Rogoff (2009)). This strongly suggests that there is a sense in which debt can become excessive. But when?

We take an empirical approach to this question. Using a new dataset on debt levels in 18 OECD countries from 1980 to 2010 (based primarily on flow of funds data), we examine the impact of debt on economic growth. Our data allow us to look at the impact of household, non-financial corporate and government debt separately.

In this section, we briefly review trends in household, non-financial corporate and government debt. In what follows, we will refer to the total combined debt of these three sectors as the total non-financial debt.

As shown in Graph 1, from 1995 to the middle of the last decade, public debt had been relatively stable as a percentage of GDP. But this period of relative public sector restraint was accompanied by a rapid rise in household and non-financial corporate debt. The righthand panel of Graph 1 makes the rather stark point that real household debt tripled between 1995 and 2010, dwarfing the accumulation of debt in other sectors of the economy.

The place that Supply is deemed not to matter? Finance.

Here's a older graph, from a Seeking Alpha post of January '09 by ContraHour:


The highest line there, the pink one, is the total of all the other lines. That's the problem, yeah, total debt. But just look at the components. Just look at one of them. On the right side, the second highest line -- highest among the components -- is Financial debt. "Domestic Financial" debt.

On the left side, at the start, Financial debt is the lowest.

In other words, Financial debt was the fastest growing component of Total debt. Not household debt or any of the others. Financial debt.

Oh, by the way, they're all bankmen:

Cecchetti is Economic Adviser at the Bank for International Settlements (BIS) and Head of its Monetary and Economic Department; Mohanty is Head of the Macroeconomic Analysis Unit at the BIS; and Zampolli is Senior Economist at the BIS.

Maybe they have a vested interest in failing to see financial debt as a problem. That would be like me saying household debt does not matter, something I do not say.

And yes: It would be like the private sector pointing the finger at public debt.

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