The Debt Trap: Can We Avoid It?

Abstract

The stock of global debt is the immediate and most tangible impediment to the demographic fallout we have described. The extended leverage of non-financial companies, and of households in some countries, will be the greatest constraint on the future normalisation of nominal interest rates, since any sizeable or abrupt rate hike would cause bankruptcies and recession. But if interest rates stay low, the incentive to increase indebtedness remains. The best way to escape this debt trap would be via faster growth, but the forecast decline in the workforce largely precludes that. An unexpected rise in inflation is much more likely, but that would imply that Central Banks cannot meet, or are prevented from meeting, their inflation targets. Renegotiation of, or default on, such debt may also play a role, but this is a messy process involving considerable costs to everyone involved (except the lawyers).