Rogoff & Lo: Debt Overhangs Continue to Weigh on Global Economic Recovery

High levels of debt are slowing global growth and preventing a recovery, according to a new paper by Stephanie Lo and Kenneth Rogoff.

Debt Remains High by Historical Standards

In their paper, the authors argue that debt-fuelled investment largely caused the financial crisis in 2008 and show that the amount of debt held across all sectors (public, corporate and household) in developed countries remains it historically high levels and remains a significant risk, despite the perception that the world economy has moved on from the 2008 financial crisis.

Total Debt Held in 22 Economies as % of GDP, 1970-2013

Source: Rogoff & Lo, 2015

Debt Build-Up Consistent Across All Sectors

  • For governments, heavy debts caused by high borrowing to support the economy during the early stages of the crisis have reduced available funds to invest now, because of increased pressure to pay back debt. Furthermore, the weak economic outlook and disgruntled voters make growth through reform even more difficult, as is the case in Europe and Japan.

  • In the private sector, a run up in debt prior to the crisis and weak growth in subsequent years means that companies have either been reluctant to make further investments or have defaulted on debt, with the latter case causing significant problems in the banking sector.

  • For consumers, it is a similar story, made worse by government reticence to boost growth through spending and corporate misgivings about increasing employment or wages. This is a particular problem in advanced economies, where consumer spending accounts for between 70-80% of total GDP.

Weak Consumption, Population Aging Impacting Government Finances

The authors acknowledge that other causes can also explain the picture, such as ageing populations causing a squeeze on consumer demand and a failures of government policy to address the crisis. However, their point about the negative feedback loop from weak consumption to worsening corporate sentiment to pressure on government finances is a strong one.

Debt Levels and Strategies to Handle Them Need to Feature More Prominently in Public Debate

The paper offers no policy recommendations for governments but the central thrust reinforces the point that - despite positive news on the economic front in the US - debt should remain front and centre for any government looking to negotiate the coming years.

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