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5 Policy issues
5.1 What have we learnt from past crises
In our report we have focused on both the debt build-up preceding the last ‘great’
crisis and the post-crisis adjustment. Our analysis suggests that, pre-crisis, debt
in advanced economies had increased above their capacity to bear it. Amongst
emerging markets, China may now be in a similar situation and other countries
in that group also show signs of fragility.
From an ex ante perspective, policymakers must seek to prevent excessive debt
accumulation because this makes the economy vulnerable to macroeconomic
and/or asset price shocks which, in turn, may require subsequent painful
adjustment. 27 Ex post, if an adjustment must take place, policy also has a role to
play in alleviating its costs to the economy. Our case studies evaluate the results
of different policy choices and point to difficult trade-offs between further debt
accumulation to prevent stagnation of the real economy and debt consolidation
at the cost of stagnation.
In what follows, we highlight the main policy lessons that we draw from the
experience of the last 20 years.
(i) Preventing excessive leverage and debt crises
In effect, it is a policy decision to let a country lever up above its means (that
is, above its debt capacity). This may happen because policymakers view
extremely high economic growth rates and advantageous borrowing conditions
as permanent rather than temporary (as was the case in Ireland and Spain during
the convergence period and after the launch of the euro), or because they use
leverage to try to fight a persistent private-sector slowdown (as in China since
2008), or perhaps because they are just trying to squeeze the benefits of financial
innovation to grow above the potential rates determined by the supply side of the
economy, as was the case in the US at the beginning of this century. Moreover, in
some cases, policymakers acted as cheerleaders for the process of excesses in the
private sector and exposed the balance sheets of central and local governments to
similar vulnerabilities. Thus, a clear-eyed recognition of the actual debt capacity
27 The political economy of debt management is made more complex by the possible interconnections
between the growth in household debt and underlying shifts in income distribution (see, amongst
others, Rajan, 2010).
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