Debt is viewed as a curse by many people. When lots of debt is accumulated, especially over a shorter period, everyone is bracing themselves for its devastating effects. This is the power of debt, both private and public.
But what many are not aware of is the impact that corporate debt and household debt have on the economy. Household debt refers to the different liabilities of households that need interest payments or principal by households to the creditors at upcoming fixed dates. On the other hand, corporate debt refers to funds borrowed by firms for business purposes.
So, how do they affect the economy? Let’s take a look at some results revealed in studies.
The Recent State of the Economy
It’s not a surprise that the economy goes through both good and bad moments regularly. But while good times are very much awaited, bad ones are feared, and many hope they can find a way to put an end to them.
Recently, there was a fiscal crisis in advanced economies known as the eurozone sovereign debt crisis. On the other hand, in emerging market economies (EMEs), there were several fiscal crisis episodes.
It’s important to note that while public debt can be very bad for the real economy and the financial system, private debt can be just as harmful. In 2008-2009, the global financial crisis (GFC) ended up disrupting the entire world’s economy and financial system. The crisis was caused by the quick accumulation of household debt in the U.S.
Before the 1997-1998 financial crisis in Asia, many companies and banks from East Asia borrowed U.S. dollars for the short term. The goal was to finance various investment projects that could bring long-term local currency revenues.
After the GFC, there were huge amounts of money borrowed by private sectors of EMEs due to the low global interest rate. Because of this, many specialists are worried about the outstanding and growing household debt for the Republic of Korea, the People’s Republic of China, Thailand, and Malaysia.
On top of that, when there is an unsustainable, fast expansion of private debt, the financial system can become unstable, which can hurt economic growth.
What Is the Impact of Household Debt and Corporate Debt on the Economy?
What we know so far is that in EMEs and advanced technologies, there is more corporate debt compared to household debt. However, household debt tends to increase at a faster rate. Meanwhile, every year, the percentage point for corporate debt gets higher and higher.
When household debt builds up, output growth increases for a while. Nevertheless, this points to a much lower output increase after 3 years. On the other hand, corporate debt buildups don’t have the same influence on output growth in the short run. In fact, they tell you that in 1-3 years, the output growth will be lower.
Alistair Vigier, a real estate journalist, said that the smaller estimated corporate debt coefficient’s bad impact on output growth can be compared with that of household debt buildups. As for the impact on investment growth, it’s very likely for corporate debt to have a more intense negative impact on it compared to household debt.
Moreover, housing and stock price growth rates can also be affected by buildups in corporate and household debts.
For instance, corporate debt has a bad effect on it, whereas household debt can result in rises in housing prices and comparable increases. This applies mainly to advanced economies. When it comes to EMEs, corporate debt doesn’t have any influence, whereas household debt only has a bad impact on house costs in the medium run.
Another thing that you should know about is that in advanced economies, corporate debt has a faster negative effect on stock prices, but it becomes positive in the future. Household debt can only have a bad effect on stock prices in the medium run, though. In EMEs, corporate and household debts point to decreased stock prices, with the former having a quicker impact.
In Thailand, the Republic of Korea, the People’s Republic of China and Malaysia, corporate debt buildup can bring more financial peaks compared to household debt buildup. However, according to studies, recessions induced by household debt do not inflict as much damage on output compared to corporate debt.
Academic studies have revealed how household debt boosts are associated with higher unemployment rates, lower output growth, as well as an increased likelihood of banking crises in the future. This is important to keep in mind, especially for people who own or want to open brokerage firms.
About the author:
The author Allan Smith is a professional finance writer specializing in personal finance. He has worked in the finance sector for a long time. He believes that everyone’s economic and life situation is isolated, and he keeps this fact in mind while providing personal finance advice in his blog Day to Day Finance. All people seeking financial guidance are in different stages of life. Allan loves to explore every possible angle of personal finance so that anybody can get help.
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