Leveraged

The New Economics of Debt and Financial Fragility

University of Chicago Press, 2022

15 min read

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Credit bubbles and financial leverage are responsible for modern financial crises.

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Inspired by the disruptions caused by the 2008 financial crisis and the COVID-19 pandemic, this collection of essays offers an engaging overview of the latest thinking in economics and its practical implications. Many of the conclusions presented here question the pre-2008 assumption that financial systems will be just fine, as long as free markets and private incentives prevail. The work of the late, great Hyman Minsky – who explained human nature’s tendency toward boom-and-bust cycles – is a recurring theme and inspiration. Edited by professor Moritz Schularick, this notable book shows how credit and leverage are fundamental factors in recent crises.

Summary

Credit booms distort economies, and economic slowdowns inevitably ensue.

The current regulation of the financial system is too focused on minimizing the risk of banks getting into trouble. The biggest impact of financial crises lies in the accompanying dramatic drop in consumer spending and loss of confidence in the wider economy. Sharing the risks of the fallout when the economy turns would be a better approach.

One crucial way to tackle this would be the use of “state-contingent contracting” (SCCs) in which, during a downturn, contracts automatically reduce the amount a borrower needs to pay back. Examples of SCCs already in use include student loans in which the payback is contingent on the borrower’s earnings, as well as loans to countries in which the repayment depends on GDP growth. A crucial SCC policy would be a “shared responsibility mortgage” (SRM), whereby homeowner repayments would reduce when house prices fell.

Credit booms distort a country’s economy, as more labor, business capital and private credit go toward real estate, construction and domestic consumption, and imports increase. Meanwhile, rising...

About the Author

Moritz Schularick is a professor of economics at Sciences Po in Paris and the University of Bonn, Germany. The authors of the sections are associated with the Institute for New Economic Thinking.

Moritz Schularick

Leveraged

The New Economics of Debt and Financial Fragility

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Summary

Credit booms distort economies, and economic slowdowns inevitably ensue.

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