## Dependence on credit to boost demand imperils the world economy—we must correct the underlying imbalances

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**Canonical URL:** [Dependence on credit to boost demand imperils the world economy—we must correct the underlying imbalances](https://www.imf.org/-/media/files/publications/fandd/article/2024/03/how-econ-must-change-mian.pdf)

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### Behind the imbalances
- Two main forces behind the rise of imbalances that have generated the debt supercycle:
  - the saving glut of the rich (a consequence of rising inequality).
  - the global saving glut (driven by a group of countries, including China).
- Empirical and behavioral points:
  - "The share of disposable income going to the very rich (top 1 percent) has been steadily rising since 1980."
  - "Since the rich also tend to save a much higher fraction of their disposable income, rising inequality has led to a large surplus of savings accumulated by the very rich."
  - Certain countries "have been earning a larger share of global income and also save at a much higher rate through various government institutions, such as central banks and sovereign wealth funds."
- Combined consequence:
  - "The combined consequence of these two imbalances is a rise in financial surpluses, which have financed the global debt supercycle."
- Role of the financial sector:
  - It intermediates by taking financial surpluses from rich individuals and countries and lending them to segments of the economy.
  - A well-functioning financial sector would channel surpluses toward productive investments (infrastructure, technology), making resulting debt sustainable.
  - Instead, "a key feature of the debt supercycle is its failure to finance productive investment."
  - Evidence: "Even though total debt as a share of GDP has more than doubled, real investment as a share of GDP has remained stagnant, or even fallen over the past four decades."

### Debt supercycle and indebted demand
- Definition and dynamics:
  - The debt supercycle is "the product of an ever-increasing buildup of borrowing by consumers and governments."
  - Short-term: both debt-financed consumption and investment boost aggregate demand similarly.
  - Long-term divergence: "debt-financed consumption, or 'indebted demand,' has different implications in the long run when indebted consumers repay their lenders."
  - Repayment requires cutting consumption, which "puts a drag on aggregate demand, since savers are less inclined to spend the paid-back funds on consumption."

### Pushing rates down
- Mechanism:
  - Indebted demand pulls down aggregate demand in the long run; the economy compensates by lowering interest rates.
  - "Lower rates help ease the debt-service burden for borrowers and push aggregate demand back up."
- Consequences:
  - "The rise of the debt supercycle is associated with a persistent fall in long-term interest rates as well."
  - Numeric evidence: "The 10-year US real interest rate has declined from about 7 percent in the early 1980s to zero or even negative values in recent years."
  - Lower long-term rates raise asset valuations and "further worsens inequality."
- Paradox highlighted:
  - Despite "the large decline in interest rates and abundant financial surpluses," real investment has not increased.

### World economy’s vulnerabilities
- Fragility of debt-dependent demand:
  - "An economy that relies on a constant supply of new debt to generate demand is always susceptible to disruptions in financial markets, which can trigger serious slowdowns."
  - Historical note: "This is what happened in 2008 with household debt."
- Shift in reliance:
  - Since 2008, "the economy has relied more on government debt to generate demand."
  - Governments in advanced economies can often borrow at a rate lower than their rate of growth, facilitating continuation of the debt supercycle—but this is "politically risky" and depends on financial market stability.
  - "Recent rate hikes in many countries demonstrate that this reliance cannot be taken for granted."
- Structural nature of the problem:
  - Traditional fiscal and monetary tools address cyclical problems but not the structural imbalances driving the debt supercycle.
  - Looser monetary policy may temporarily boost demand but can reinforce indebted demand and delay resolution: "We have at best been kicking the proverbial can down the road, and at worst further impeding eventual resolution of the debt supercycle."

### Policy directions and recommendations
- Rebalancing objectives:
  - "The economy needs to find a way to rebalance and reverse the debt supercycle."
  - Structural changes to make growth more equitable would "naturally reduce the scope for imbalances."
- Tax policy:
  - "Taxing wealth beyond a certain threshold can promote more spending by the very wealthy."
  - Increased consumption by the very wealthy would "reduce the saving glut of the rich that finances the unproductive debt cycle."
- Supply-side reforms to expand productive investment opportunities:
  - "Removing restrictions on new construction."
  - "Promoting competition."
  - "Boosting public investment."
  - The goal: enable debt to fund productive investment rather than "unproductive indebted demand."

- Summary diagnostic:
  - Debt supercycles reflect both demand-side problems (rising inequality and the saving glut of the rich) and supply-side problems (a highly restrictive investment response despite low interest rates and abundant financing).

*Atif Mian, F&D, MARCH 2024.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2024/03/how-econ-must-change-mian.pdf_