Increased levels of debt, relative to GDP, have boosted economic growth globally this year, but there could be severe consequences, according to the International Monetary Fund (IMF).
The organisation said: “Debt greases the wheels of the economy. It allows individuals to make big investments today–like buying a house or going to college – by pledging some of their future earnings.
"That’s all fine in theory. But as the global financial crisis showed, rapid growth in household debt – especially mortgages – can be dangerous.”
The IMF said economic policy is a “trade-off” between “the short-term benefits and the medium-term costs of rising debt.”
In the UK, the Financial Conduct Authority (FCA) warned about rising debt levels in the economy, as has the Bank of England.
This IMF paper is written by central bank policy makers, and central bank policy around the world in the decade since the global financial crisis has centred on historically low interest rates and quantitative easing, both policies which push borrowing costs down, and debt levels up.
The IMF said: “ Given the widespread misery the crisis caused, you might think people have become skittish about borrowing more. Surprisingly, that’s not the case. Among advanced economies, the median debt ratio rose to 63 percent last year from 52 percent in 2008. Among emerging economies, it increased to 21 percent from 15 percent.”
The fund manager David Jane, who runs £770m across three funds at Miton, said the problem with monetary policy since the financial crisis is that the money pumped into the system has gone to the old and wealthy, who are less likely to spend it.
Meanwhile education fees and housing costs rise, meaning the young have less disposable income, but it is the young who are inclined to spend the greater part of their income, he said.
This means, in his view, that economic growth has not been particularly aided by central bank policy, while debt levels have risen.
The IMF paper said the short-term impact of higher debt is economic growth and falling unemployment, but that this “reverses” within about four years, and unemployment rises.
The paper concluded “More specifically, our study found that a 5 percentage-point increase in the ratio of household debt to GDP over a three-year period forecasts a 1.25 percentage-point decline in inflation-adjusted growth three years in the future.
"Higher debt is associated with significantly higher unemployment up to four years ahead. And a 1 percentage point increase in debt raises the odds of a future banking crisis by about 1 percentage point. That’s a significant increase, when you consider that the probability of a crisis is 3.5 percent, even without any increase in debt.”
David.Thorpe@ft.com
