The Debt Under the Background of Financial Crisis

The long-term impact of the financial crisis on the real economy is an unsolved mystery. This is because the so-called crisis was originally a short-term event. As Kozlowski, Veldkamp, and Venkateswaran (2016) pointed out, so far the study has concluded that the shock that caused the long-term recession continues to occur. But Kozlowskietal explained that only one crisis will permanently change people's prediction of tail risk. This article focuses on the short-term financial crisis that has led to other long-term changes in the real economy, that is, huge excess debt accumulated by businesses and households. According to our theoretical study (Kozlowski and Shirai 2017), once temporary excess debt has been accumulated, even if financial technology has not changed, it may lead to long-term stagnation.

Whether or not debt accumulation has become a cause of long-term recession is of fundamental importance for evaluating policy recommendations. If the long-term decline stems from exogenous technical shocks (eg Gertler and Kiyotaki 2010, Christiano, Eichenbaum and Trabandt 2015), or because expectations of tail risk do change (Kozlowski et al. 2015), policy makers improve. What the recession can do is nothing but a loose monetary policy. This is because there is no way to directly eliminate exogenous shocks or tail risk expectations. In contrast, if the recession stems from the accumulation of excess debt, simply reduce the debt. The so-called debt reduction is not limited to those who liquidate and handle debts of excess debt, but also includes relief through debt relief and debt securitization. Under such circumstances, extraordinary monetary fiscal easing may be effective in alleviating severe recession. But in the final analysis, its role is merely delaying time rather than eliminating the recession. If the deep-seated problem of long-term economic stagnation is excess debt, policy makers will need to increase their options. The framework for policy discussion is limited to monetary easing policies, fiscal policies, and options for “preliminary” monitoring of macro health. These options should be clearly compared with the “afterwards” policy measures of private sector to promote debt reduction.


In our economic model, the excess debt at different points in time acts as a “debt backlog”, which makes the constraints on the borrowing of working capital (ie the debt at the same time) even more severe. The debt backlog (Myers 1977) was not previously seen as a problem with macroeconomic policies because, under normal circumstances, the debt backlog was quickly eliminated through corporate bankruptcy procedures. Lamont (1995)'s research shows that when there is externality, the debt backlog may be the cause of economic recession. But in his model, the economic recession is temporary, and the debt backlog will be naturally and quickly eliminated. In our model, the debt backlog may persist at the corporate level for a long period of time and trigger a long-term recession that is interpreted as “Secular Stagnation” across the economy.