BEIJING – A 2010 paper by Kenneth Rogoff and Carmen Reinhart suggesting that a country’s economy will slow when public debt exceeds 90% of GDP has fueled heated debate worldwide. What is usually missing from such discussions, however, is an explanation of how too much debt leads to slower growth. Such an explanation is needed to decide whether crossing a particular threshold really is the determining factor in an economic slowdown.
In fact, it is not. While excessive debt can hamper a country’s growth prospects, it does so by inducing economic actors to behave differently, thereby generating financial-distress costs. Just as major stakeholders in a business generate such costs by changing their behavior when the firm’s balance sheet becomes too risky, an economy’s stakeholders respond to rising default risk in ways that reduce growth and, in a vicious feedback loop, increase financial fragility further. Συνέχεια