naked capitalism

The International Monetary Fund made the comments in its latest World Economic Outlook.

The IMF said such policies can substantially mitigate the negative effect of household deleveraging on economic activity.

The report noted the well established link between high levels of household debt run up during a housing boom, and the effect of a high debt overhang on economic recovery.

It found that countries, like Ireland, that saw house prices and household borrowing skyrocket, saw a longer than average period of recession after the bursting of the housing bubble.

A large part of this protracted recession it said is due to households trying to reduce their debt levels, which in turn leads to less spending in the economy, driving the recession deeper and further.

“Because debt is acting as a brake on economic growth, it is important to unstick the brake” said the report’s author Daniel Leigh. [snip]

The report highlighted what it calls the “bold ” household debt reduction programmes implemented in the US in the 1930′s and in Iceland in this crisis, which it said can “significantly reduce the number of household defaults and foreclosures and substantially reduce debt repayment burdens”.

It contrasted these examples with others that have not been successful, such as the current response to the crisis in the US and Hungary, and the policies pursued in Colombia and the Scandinavian countries in the 90′s.

As well as the “bold” approach, it said that ensuring a strong banking sector is crucial during the period of household deleveraging. It stated that the policies in Colombia and Hungary were not a success as they placed too much burden on an already fragile banking sector. [snip]

The IMF noted that government support for household debt restructuring programmes involves clear winners and losers. “The friction caused by such redistribution may be one reason why such policies have rarely been used in the past, except when the magnitude of the problem was substantial and the ensuing social and political pressures considerable”,’ it stated.

It cited another study which found that political systems tend to become more polarised in the wake of financial crises, and raised the question of collective action problems – that distressed mortgage borrowers may be less politically organised than banks – and this can hamper efforts to implement household debt restructuring.[snip]

In the case of Iceland the situation was more difficult, due in part to the much bigger proportion of the population that was affected, and to the wide presence of foreign currency mortgages.