Neglect Private Debt at the Economy's Peril

Abstract

The authors discuss the role of private debt in financial crises and attempt to apply the debt deflation logic to the data and facts surrounding the post bail-in years in Cyprus. It is found that the financial crisis in Cyprus was indeed predictable and that a key problem facing the country remains that of avoiding a balance sheet recession which threatens to impede sustainable economic growth. Another interesting finding is that for the three years after the bail-in Cyprus households have been living off their savings rather than making the required additional savings to reduce their debt and restore balance sheet positions. With greater forced or needed savings and the resultant contraction of aggregate demand a downward spiral of debt/deflation can inevitably be expected to set in along lines expounded most notably by Richard Koo. In addition policy recommendations aimed at countering the onset of a balance sheet recession are advanced.

Keywords: balance sheet recession, debt deflation spiral, sustainable growth, debt minimization, dissaving, aggregate demand, credit risk

JEL Classification: D61, G17, G21, G32, G33, H43