Excessive private sector leverage and its drivers: evidence from advanced economies

ABSTRACT

The paper provides novel quantitative assessments of the gaps between actual and sustainable levels of debt for households and corporates in selected advanced economies, revealing considerable heterogeneity across sectors and countries. The accumulation of gaps is found to precede financial distress. The paper also identifies key factors that drive excessive debt, separately for households and corporates. For households, excessive leverage is found to be higher in countries with lower interest rates and higher share of working population, but importantly also in countries with rising house prices and greater uncertainty as captured by unemployment. For corporates, debt overhang is estimated to be higher in countries with lower profitability, stronger insolvency frameworks and in absence of thin capitalization rules. There is therefore scope for the use of policy to limit the build-up of household and corporate debt overhang.

KEYWORDS:

• Household and corporate leverage
• corporate capital structure
• taxation
• private debt sustainability

JEL CLASSIFICATION:

• D12
• D14
• G32
• H31
• H32

Acknowledgment

The authors would like to thank, without implicating, David Amaglobeli, Martin Cihak, Julian Chow, Rupa Duttagupta, Emilio Fernandez-Corugedo, Sanjeev Gupta, Shafik Hebous, Dyna Heng, Jun Il Kim, Tonny Lybek, Marialuz Moreno Badia, Cathy Pattillo, Hashem Pesaran, Tigran Poghosyan, Thomas Sargent, Abdelhak Senhadji, Artur Swistak, Yi Xiong, and seminar participants at the IMF and MNB for useful comments and discussions. Kyungla Chae and Young Kim provided excellent research assistance. Any remaining errors are our own. This article represents only the authors’ views and not those of the International Monetary Fund, its Executive Board or its Management.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ In this paper, we use the terms ‘debt overhang’, ‘excessive debt’ and ‘excessive leverage’ interchangeably.

² Thin capitalization rules aim to address situations when companies incur too much debt relative to equity by restricting interest deductibility above certain level of debt.

³ For example, for households, the implicit debt valuation effects (calculated as the difference between nominal and deflated debt) are about 2 percent on average for the sample, whereas the asset valuation effects are about 16 percent.

⁴ The empirical findings on the drivers of excessive debt are broadly similar for the two alternative measures.

⁵ Specifically, national sources have been used for Spain, Portugal, Canada and Australia.

⁶ Time series for the stock of non-financial assets of corporates in Portugal were not readily available.

⁷ The correlation is measured by the point biserial correlation coefficient since one of the variables is binary.

⁸ More results to ensure robustness check are available in Appendix II.

⁹ Drawing on the political economy literature, voice and accountability as well as political stability indicators shape political power and institutions that in turn shape economic institutions, with the latter typically captured by the rule of law (Acemoglu 2005; Acemoglu and Robinson 2016, 2016).

¹⁰ Given potential residual endogeneity associated with house prices due to the fact that they may to a certain extent appear on the left-hand side, we run a two-stage system of equations with the excessive leverage and house prices as dependent variables. The results do not change martially though.

¹¹ Similarly to the rule of law, building on the political economy literature, political stability affects economic institutions, including protection of property rights and related strength of insolvency framework, through political power and institutions (Acemoglu 2005, 2016; Acemoglu and Robinson 2016).