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Is Deleveraging “Bad for the Economy”?

Posted by
December 19, 2011
in Blog

A while back there was a story in the Wall Street Journal (“America’s Debt Cutting Hampers Growth,” Oct. 22) about deleveraging in the U.S. economy. American households, burned by the recession, have a new-found frugality and are reducing their overall debt loads for the first time in decades. Looks like a lot of people learned their lessons about buying too much stuff they couldn’t afford, and are now setting themselves up for financial responsibility and long-run success. What could possibly be bad about this turn of events? Well, our Keynes-influenced friends at the WSJ found something to worry about in all this. Although they admit that “deleveraging should help the U.S. economy in the long run,” such deleveraging carries “short term dangers” to economic growth. Keynesian economic theory tells them that “Synchronized thrift slows the economy…which hobbles income growth and makes people even stingier in a pernicious cycle.” They then fret that these darn consumers just won’t start borrowing again—so they can spend again, and “get the economy moving” as if it were a stalled car short on gas.

It’s frustrating to see this kind of economic confusion in the nation’s premier business newspaper. Yes, deleveraging means reduced consumption spending, and, *gasp*, maybe even lower GDP for  awhile. But to cast a pall on deleveraging—to call it “dangerous”!—misses the whole point about excessive debt.      Yes WSJ Keynesians, we get it that if people borrow less today, they can’t buy as much stuff today. But if people borrow a lot today, they’re not going to be able to buy as much next month, and the next… until the debt is repaid. And if people borrow way too much today, they might sink themselves into bankruptcy, damaging their ability to both borrow and consume for a long, long time to come.

Likewise for governments. Yes, the less government spends today, the lower the GDP number (other things equal). But that’s no reason for governments to borrow to the hilt. Indeed, borrowing to the hilt—borrowing more than can possibly ever be repaid—will inevitably lead to bankruptcy. Good old fashioned bankruptcy (default) would mean a sudden halt to the government spending programs people have come to rely on, which invariably leads to violence in the streets. So the pols and bureaucrats opt for bailouts whenever possible, and the least obvious form of bailout is to crank up the printing press and monetize the debt. This causes inflation and a host of economic disturbances. There is no easy way out of a debt crisis. The best thing to do is de-lever aggressively as soon as you realize there’s a debt problem. The quicker people can de-lever, the quicker real growth can return, but of course the larger the initial debt problem, the longer deleveraging will take. To call this process “dangerous” because it means less spending… well that’s just nonsense. Excessive spending, financed by excessive debt, was and still is the problem. The solution is to put a stop to such irresponsible behavior.

Excessive debt burdens are bad, um’kay? High debt levels, whether for a family or a national government, are poisonous for long-term prosperity. Deleveraging is the antidote.

Tyler Watts is an assistant professor of economics at Ball State University.

image from mises.org