Doom Loop

2 Key excerpts on "Doom Loop"

• 

  eBook - ePub

  Europe Entrapped

  • Claus Offe(Author)
  • 2015(Publication Date)
  • Polity

    (Publisher)

  3 Growth, Debt, and Doom Loops

  There is a complex tangle of Doom Loops unfolding among the four macro types of economic agents. These are (a) the financial industries, (b) the state and its fiscal authorities, (c) the “real” economy, consisting of investors, workers, and consumers and (d) the citizenry of national representative democracies.

  Private investors and consumers vs creditors: “Financialization” has become a widely used descriptor of dominant trends in advanced capitalist economies. In one of the several meanings of the term, it refers to the volume of aggregate liabilities relative to GDP. This volume – the total of debt incurred by households, investors, states, and banks – has roughly doubled in the course of the last four decades in economies of the USA or Germany: from the factor of 4.5 to the zfactor of 9.1 That is to say: total debt, equal to the total assets of banks, amounts to about nine times the annual GDP.

  The private sector (made up of producers and workers/consumers) depends on credit, taken out by manufacturing and commercial enterprises for physical investment and commerce and by private households for consumption. Private production and consumption is increasingly based on credit, which is nothing but (expected) future income that is presently spent under the promise to pay it back with interest out of (realized) future income. Households and investors depend on creditors. Inversely, the readiness of banks actually to grant credit depends on lenders being provided with a – credi(ta)ble – “business plan” or (in the case of private households) employment prospects that assure creditors of the future ability of borrowers to service and eventually pay back their debt: financial institutions depend on the viability of business plans/ employment prospects of debtors. To the extent banks see reasons to doubt the creditability of borrowers, they will increase interest rates or ask for collaterals that reflect their assessment of risk. Yet, facing the burden of high interest rates, investors in the “real” economy will find it ever harder to provide a business plan that satisfies banks. The resulting credit crunch deepens the recession in ways that cannot be compensated for by even negative real interest rates offered to the banks by the ECB. If satisfactory (micro) profitability or (macro) prospects for GDP growth are seen by banks as dubious, there is no reason for them to grant credit to private-sector actors.2

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Understanding Financial Crises

  • Ensar Yılmaz(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  The accumulation of household debt can amplify downturns and weaken recoveries. In order to better understand the impacts of debt accumulation on depth of slumps, some economic models look at the case in which they differentiate between borrowers and lenders and incorporate liquidity constraints. These models, for example those developed by Eggertsson and Krugman (2012) and Hall (2011), show that distribution structure of debt among the actors in an economy is significant. This is pointed out by Tobin (1980, p.10) as follows:

  the population is not distributed between debtors and creditors randomly. Debtors have borrowed for good reasons, most of which indicate a high marginal propensity to spend from wealth or from current income or from any other liquid resources they can command.

  In parallel to this, Kumhof and Ranciere (2010) show that household debt of lower income and wealth groups increased much more in the US during the 2000s. A negative shock to debtors having a high marginal propensity to consume leads them to cut down their debt, thus deleveraging. This results in a decline in consumption, hence production at the aggregate level. The decline in consumption can accelerate along with increasing perceptions of uncertainty due to the need for precautionary saving. Households will cut their consumption abruptly.

  Sovereign debt crises have significant effects on economic activity due to the fall in credit extended by banks. Along with sovereign debt crises, countries cannot access international debt markets easily. The financial (mainly banks) and non-financial firms cannot reach foreign sources of credit. As a result, the lack of credits required for the economy will affect the macroeconomy negatively. This is a direct effect of sovereign debt crisis. However, sometimes sovereign financial stress can have indirect effects on other countries which had not suffered a sovereign debt problem directly. Thus, sovereign financial stress can also be transmitted to other countries through global banks. As banks with large international operations face capital shortfalls due to losses on sovereign exposures, they may reduce their cross-border lending arrangements in the form of syndicated loans. For example, European banks with significant exposures to sovereign securities during the European sovereign crisis reduced their global syndicated lending significantly.

  Sign up to read

  Learn more about book