Financial crises tend to be followed by a protracted period of debt reduction in the non-financial private sector, according to a report from the Basel, Switzerland-based Bank for International Settlements.
In 17 of the 20 systemic banking crises, a period of debt reduction followed, economists Garry Tang and Christian Upper wrote in the September Quarterly Review, released on Monday. Debt relative to gross domestic product decreased by an average of 38 percentage points, returning to approximately the levels seen before the crisis.
"If history is any guide, we should expect to see a much more significant reduction in private sector debt, particularly of households, than has so far taken place after the recent crisis," they wrote. "What goes up tends to come down."
As a result, the central bank for central banks noted that GDP fell by almost 8% on average after the 17 financial crises that were followed by a reduction in private sector debt to GDP. A possible concern is that a sustained period of debt reduction might lead to low growth in the future.
"It is possible to reduce debt and still experience healthy growth. For this to be the case, policy makers have first to fix the problems in the banking system that led to the financial crisis," BIS economists added.
Before the recent financial crisis, household debt in particular rose considerably in the countries that experienced a housing boom. Lower house prices may induce households to reduce their desired levels of debt.
In the United States, both house prices and the ratio of household debt to GDP peaked in the middle of 2006 in the wake of higher interest rates and slowing economic activity. But over the last three years, U.S. households have been reducing their debt ratios. Meanwhile, the picture is less clear in other countries that experienced a housing boom.
Figures from BIS showed a sharp fall in activity in the primary market for international debt securities in the second quarter of this year. Completed gross issuance declined by 23% to $1,664 billion, which was the lowest since late 2005 and well below the levels seen during the financial crisis. At the same time, net issuance dropped by 83% to $99 billion, the lowest since the late 1990s.
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