It’s all about that debt
18 April 2017
With hindsight, it takes just a cursory glance at credit dynamics to see that the global economy was headed for trouble in 2008. A large and sustained increase in developed market leverage sowed the seeds for the painful crisis that followed. The tone over the current cycle has been different. In aggregate, developed markets have undergone an adjustment from past excesses, with corporate and household sector debt ratios falling, before stabilising more recently. The emerging market (EM) cycle has been somewhat out of sync. China’s building credit imbalances have been well-publicised and continue to grow. Even excluding China, emerging economies have leveraged up since the crisis, although credit growth has moderated over recent years. In spite of this, there are few signs that large and widespread financial imbalances are building in the global economy, in the same way that we saw in the early to mid-2000s.
While this headline story sounds benign, there are a couple of caveats. First, when we move away from the aggregate data, there are ‘pockets of heat’ creeping into certain sectors and economies. In the US we have seen motor vehicle loans surge, while broader consumer credit in the UK has also accelerated. However, policymakers can take some comfort from the fact that these exposures are much smaller than the housing market excesses that preceded the financial crisis. On this note, some smaller economies are seeing imbalances build in this more systemic sector. This is true of Australia, New Zealand, Sweden, Norway, Korea and Switzerland. In all of these countries we have seen an active debate around how policy should respond. In general the consensus seems to be that macroprudential policy forms the first line of defence, allowing monetary policy to support the broader economy. However, there is still nervousness around the efficacy of this policy approach. The other caveat is that while leverage has not been increasing, it remains high in many economies. High debt levels can weigh on growth through lower investment and consumption; raise the risk and severity of future crises; and make the economy more sensitive to rising interest rates. Central banks will have to weigh all these issues carefully as and when they look to remove policy accommodation over coming years.