Aasof’s Reflections

A recent article; 138 Years of Economic History Show that It’s Excessive PRIVATE Debt Causes Depression, states that government debt – over a certain level – does matter as it forms a drag on the economy, but private debt kills it.

Focusing on private sector debt (credit), the article referenced a National Bureau of Economic Research (NBER) working paper, The Great Leveraging, which analysed 138 years of economic history in 14 advanced economies.

The NEBR paper concluded that high levels of private sector debt is a more accurate predictor of severe recessions.

A study of these advanced economies established a link between the growth of private sector debt (credit) and the likelihood of a financial crisis. This link between a financial crisis and credit being stronger than that between a financial crisis and growth (either in the broad money supply, the current account deficit, or an increase in public sector debt).

Over the 138-year time-frame, crises preceded by the development of excess credit, as in Ireland and Spain (and the UK*) today, are more common than crises underpinned by excessive government borrowing, like in Greece.
[Peter*]

Excess private sector debt (credit) being the main driver of deep recessions and depressions, brings little comfort to the taxpayers who, having always paid for public sector debt, now find themselves bailing out the private sector debt (credit) creators.

Having continued to bail out the sources of private sector debt (credit), the UK Government’s Budget Reports effectively combined private sector debt and public sector debt in the 2012 report.

The 2010 Report stated that: “Over the past decade, economic growth in the UK has been driven by the accumulation of unsustainable levels of private sector debt and rising public  sector debt. While rising debt was an international phenomenon, it was more pronounced in the UK than in most other countries. It has been estimated that the UK has become the most indebted country in the world.”

The 2011 Report reiterated that: “Over the pre-crisis decade, developments in the UK economy were driven by unsustainable levels of private sector debt and rising public sector debt. By 2007, the UK financial system had become the most highly leveraged of any major economy. 

The 2012 Budget Report puts public sector debt first, with the only reference to ‘unsustainability’ being to levels of public spending. It  stated that:  “The financial crisis of 2008 and 2009 exposed an unstable and unbalanced model of economic growth in the UK based on ever-increasing levels of public sector and private sector debt. As a result of that crisis, and unsustainable levels of public spending, the Government inherited the largest deficit since the Second World War and the UK economy experienced the biggest recession of any major economy apart from Japan.”

The implication being that private sector indebtedness was really of minor importance, compared to public sector debt. The reality being that the reverse is true.