Impact Of Economic Slowdown of a Country on Debt Recovery Process

Posted by Anushree Sharma on March 20th, 2023

Introduction

Most economists struggle to comprehend why excessive debt may hurt an economy, let alone how much debt constitutes excessive debt. To make matters worse, it is useless to compare the debt-to-GDP ratios of significantly diverse nations in order to predict how each country would handle its debt burden.

Although many economies experienced output falls in comparison to pre-crisis patterns, post-crisis experiences varied across nations. More so than others, advanced economies and low-income developing nations exporting commodities were affected.

This diversity was caused in part by the various types of shocks that other nations experienced. As a result of the global financial panic, some countries experienced serious banking crises, while others observed slower activity in advanced economies reverberate globally through trade and financial channels.

If Debt is A Problem, When?

Rising debt has various effects that can be detrimental to an economy's performance both now and in the future. In such situations, only debt recovery is possible by approaching the professionals of this industry. Transfers, financial difficulty, bezzle (or fictitious riches), and additional spill over adjustment costs known as hysteresis are some of these.

• Transfers: As was described above, there must be some sort of automatic adjustment mechanism that transfers revenue from one sector of the economy to another in order to restore equilibrium when rising government debt causes an ex-ante imbalance between total demand and total supply in an economy. Although it is not always the case, this transfer mechanism has the potential to directly harm economic progress. The principal, and possibly the only, adjustment mechanism acknowledged by naive supporters is this.

• Financial distress: Increasing public debt can sometimes subvert economic expansion inadvertently. When there is enough ambiguity surrounding how actual debt-servicing costs will be distributed through the explicit or implicit transfers mentioned above, different economic sectors may alter their behaviour to insulate themselves from having to bear the whole burden of the debt. These behavioural adjustments either hinder economic growth, make the financial system more fragile, or both. Moreover, this behaviour has a strong tendency to reinforce itself.

• Hysteresis: Lastly, as adjustments take place, increasing debt may result in a type of hysteresis where the equilibrating adjustment mechanism results in further future adjustment costs. The most prominent instance is when increasing public debt causes a financial crisis, which then either forces the economy into debt-driven deflation or ushers in a political crisis. Most economists, when asked to explain why too much debt is a problem, will reply that debt becomes a problem to the extent that it leads to a financial crisis. This argument is flawed for several reasons in addition to being completely circular. Simply put, a crisis is only one method an economy can recover from unreasonably high debt levels, and it's not even the most expensive.

When one or more of these responses are triggered as a result of debt, economic development is slowed. While the last mechanism is essentially self-explanatory, the other three ways each of these mechanisms operates are worth considering in more detail.

Consequences

The policy initiatives of the previous ten years increased demand and stopped a worse outcome with deeper output and employment losses. The banking industry is now safer thanks to financial regulatory reform.

Several of these programmes, meanwhile, had substantial unintended consequences. In affluent economies, the prolonged period of ultra-low interest rates has contributed to the development of financial vulnerabilities, especially outside the regulated banking sector. Furthermore, the rapid increase in public debt and the depletion of fiscal safety nets in many economies highlight the necessity of quickly re-establishing those safeguards in order to be ready for the next downturn.

Dealing with these unintended consequences of the exceptional policy efforts of the past ten years is vital for being able to respond to the next crisis.