Deleveraging, What Deleveraging? The 16th Geneva Report on the World Economy

Monday, September 29, 2014

It is widely accepted that high levels of debt (of various forms) have played a central role in the 2008-09 global financial crisis, the 2010-12 euro crisis and many previous crisis episodes. The adverse macroeconomic impact of deleveraging also helps to explain the slow pace of recovery among the advanced economies in recent years, while the post-2009 surge in debt accumulation in a number of emerging markets (especially China) raises the prospect of a new wave of debt-related crises unless corrective policies are implemented.

The 16th Geneva Report on the World Economy provides a multi-dimensional perspective on leverage for both advanced and emerging economies. The report’s comprehensive approach includes both public and private debt, with the latter broken down on sectoral lines (households, non-financial corporates, financial sector). It emphasises the macroeconomic impact of leverage, with a sharp distinction between ‘normal’ recessions and the long-lasting impact on output generated by excessive leverage and financial crises.

The report shows that the world has not yet begun to de-lever and global debt ratios are breaking new highs. At the same time, in a poisonous combination, world underlying growth and inflation are also lower than previously expected, reducing global debt capacity.

The authors argue that central banks in advanced economies should be slow to raise interest rates, given the fragile deleveraging process. Moreover, the European Central Bank should pursue an aggressive policy of quantitative easing in order to fulfill its mandate of price stability while fostering debt stabilisation and easing credit conditions.

However, successful exit from a leverage trap also includes appropriate fiscal and macro-prudential policies, together with the restructuring of private-sector (bank, household, corporate) debt and sovereign debt where required. Furthermore, given the risks and costs associated with excessive leverage, the authors argue that more needs to be done to improve resilience to debt shocks and discourage excessive debt accumulation.