Private debt reduction and growth

1. Private debt reduction and growth Előd Takáts and Christian Upper The views expressed here are our own and do not necessarily represent those of the Bank for International Settlements.

2. Motivation • Major financial crisis • Private debt has increased massively before the crisis • And the economy might deleverage in the future • Question: How private debt reduction affects growth?Debt reduction vs. forbearance • Answer: it does NOT matter • Focus on more important (structural) policies

3. The current financial crisis: Non-financial debt • Private debt increased before the financial crisis • Public debt ratios fell before the crisis, but have shot up since • Output is declining or at least weak

4. Past experience: What goes up comes down

5. Roadmap • Motivation: what shall we do with private debt? • (Literature) • Data • Analysis • Conclusion: it does not matter how it comes down

6. Literature: debt and recovery post-crisis • What goes up comes down (Tang and Upper, 2010) … • Inconclusive theory: • debt overhang (Lamont, 1995; Philippon, 2009) • bankruptcy costs • Empirics: Creditless recoveries are possible • Calvo et al (2006): “Phoenix miracles” • Claessens, Kose & Terrones (2009): creditless recoveries do exist • Abiad, Dell’Ariccia & Li (2011): they exist, but are rare and have lower growth than other recoveries • Kannan (2010): industries depending more on external financing grow more slowly after financial crises

7. Data • Start with 40 financial crises in Cecchetti et al (2008) • 187 crises in Reinhart and Rogoff (2008) • 124 crises in Laeven and Valencia (2008) • 19 financial crises with prior credit boom in the database • 40 financial crisis • - 7 transition economies • - 3 hyperinflation • - 5 data problems • - 6 no credit boom prior the crisis • 15/19 followed by private debt reduction

8. Argentina 1995* Argentina 2001 Chile 1981 Colombia 1998 Dominican Republic 2003 Finland 1991 Indonesia 1997 Japan 1997 Korea 1997* Malaysia 1997 Mexico 1994 Nicaragua 2000 Norway 1991 Paraguay 1995* Philippines 1997 Russia 1998 Sweden 1991 Thailand 1997 Uruguay 2002 Crises * no credit bust

9. Our contribution • Identify crises that were preceded by a credit boom • Study changes in debt ratios after these crises • Relate changes in debt ratios to speed of recovery

10. Measuring debt ratios Debt = Domestic bank credit to the private sector (BIS databank, IMF IFS) + Claims by foreign banks (BIS consolidated banking statistics) • Debt definition excludes: • Bonds and other debt securities • Loans by other financial institutions (eg insurance corporations) • Securitised credit (unless held by commercial banks) • Trade credit • Not directly comparable to Flow of Funds data

11. Empirical strategy • Look at growth during the recovery phase from the crisis • Assumption: crisis-related output drop is over • Difference-in-differences approach: regress differences in growth rates on differences in the speed of debt reduction • Control for size of drop in output • Debt measures for empirical work: • Nominal debt • Real debt • Debt-to-GDP ratio

12. Debt reduction and growth: correlations Change in debt during recovery Drop in output during crisis GDP growth during recovery

13. Correlations (or the lack of them)

14. Correlations with controlling for public debt changes

15. Past experiences: and the exchange rate

16. Correlations with controlling for real exchange rates

17. Correlations with controlling for crisis private debt changes

18. Policy implications • The speed of debt reduction does not matter • Insignificant statistical correlation and • Small economical impact • Policies should focus on other areas (e.g. structural reform) • Real exchange rate depreciations mitigate output loss • Bad news #1: everybody can not devalue at the same time • Bad news #2: not everybody is able to devalue • Caveats