For many years, financial crises have been believed to be the preserve of the developing countries which are believed to be more vulnerable than the developed country as explained in the video “The Financial Crisis & Public Debts Explained in Detail”. However, this notion was overturned in the year 2007 – 2008 financial crises that hit the ‘great’ countries in the world. From this experience, it is evident that all countries are at risk of experiencing financial crisis regardless of the policies in place. Nevertheless, the approach towards the arrest of the crisis is what defers. In developing countries, the effect of the financial crisis persists while, in the developed countries, it only last for a while as they are fast in designing and implementing new financial policies that counter the crisis immediately. It is notable that even after these develop countries adopt the counter policies, the results do not come as fast as may be expected thus the recovery process can be said to be weak. The delay in recovery can be attributed to the negligence of policymakers in these countries who tend to underestimate the intensity of the crisis.
Public debts have been one of the most common ways of dealing with the financial crisis. For example, several countries Europe transformed the financial crisis into sovereign debt crisis. The crisis is borne as a result of policymakers thinking that stability can be achieved through policies besides the standard toolkit used by developing nations. Such common approaches include higher inflation, debt restructuring, significant financial repression and capital controls. The world super powers think that doing so is like foregoing their credibility thus worsening the condition instead of seeking the required immediate solutions. As a result, the state of living deteriorates and the citizens suffer from the poor economy. The view that the financial crisis such as the U.S submarine mortgage crises and the European sovereign debts crises should be handled differently is a pure misconception and antagonism of the history. The history has it that the financial repression, conversions or debt restructuring, have used widely in the advanced economies during the resolutions of significant debt overhangs.
Policy makers are involved in the management of public expectations. The consistent choice of instruments and calibration of responses under high level of optimism is by itself a risk of loss of integrity and destabilization of expectations not the vice versa. In the pre-Second world war period, the advanced countries were never hesitant to use the debt conversions, public debt restructuring, default, debt conversions and financial repression as a means of deleveraging. The prevalent misconceptions about these methods have resulted to formulation of policies which increases the total cost of deleveraging. It is surprising that the policy makers seem to be oblivious of this fact.
This paper examines the issue of the financial crisis in its relation to public debts in details referring to various cases in Europe and USA. The paper aims at sending more lights on these issues as they have emerged to be great threats to the world’s economy. The developed world countries and the developing countries are generalized in this discussion although more emphasis is given to the developing world. The relationship between the financial crisis and public debt is enumerated describing what cause the other and what necessitates it. The impacts of the financial crisis and public debt on the living standards of the citizens of the affected countries are also highlighted throughout the paper.
In recent years, there has been a series of studies on the financial crisis that have enhanced the economists’ knowledge in this area. There have been experienced significant growth and development of the economy coupled with increasing private indebtedness. As a result, waves of the financial crisis have been generated. The exit of economies to financial repression marked an entry to the financial crisis. This statement is substantiated by the finding that many crises are born from faulty financial liberalization. Although this is common with the developing countries in the past, the developed ones are not an exception in the today’s economy.
Financial repression refers to the common behavior of governments borrowing directly domestic dependent or government monitored kitties such as pension funds or else impose caps on interest rates, cross-border capital movement regulations as well as enhancing the connection between the government and the financial institutions such as banks. Financial repression is a reflection of debt restructuring and has been used over a long period in history. Researchers on monetary policies have found that its operations are founded on the redistribution of wealth between the borrowers and savers even in the normal economic times. The public debts are exploited on the knowledge that tightening the monetary policies and increasing the interest rates will benefit the savers while the borrowers’ benefits when the monetary policies are loose, and the interest rates are low. The government as borrower also benefits from such a monetary environment and the problem builds since the monetary policies are also formulated by the government. However, a financial repression minimizes the financial excesses hence associated with the reduction of frequency of financial crises.
The impact of the overall debt problem especially in the advanced countries is becoming too huge to ignore. The debt problem coupled with the prevailing societal problems such as expansion of the state social welfare, aging society stagnation of population growth makes it difficult to cultivate a persistent economic growth. The huge government debts ahead of the financial crisis have been increasing its negative impact on the economy. From the analysis of the recent trends of the financial crisis in both the developed and emerging markets for the period between the year 1900 and 2011, it can be observed that the developing countries tend to reduce the debts before the crises unlike the developed markets which increase the leverage level prior to financial crisis thus fueling it. This is behavior is not only fatal to the economy but also discouraging to the citizens who expect the best from the managers of the advanced economies.
Inclusion of state and local liabilities as a measure of debt does not exist in history. In fact, such techniques only serve to increase the burden of the public debt. The advanced economies have the tendency of using the gross debt instead of the net government debt since the net government debt, the pensions and medical benefits liabilities will be shown thus making it even worse. External debt, on the other hand, is also an important indicator of overall vulnerability. As the advanced economies increase their eternal debts, the emerging economies are deleveraging making a great difference between the two. The total external debt is an important marker because the line between public and private debt can become thinner in a crisis. In particular, external private debt, especially that of banks is a hidden form of debt that only surfaces during the times of crisis. This is because, long before the discovery of anomalies in the balance sheet of a bank, it used to hide the exact economic risks associated with the institution. The existing measures of public debts can be said to understate the public debts and hence understate the prevalent vulnerability. Just as bank balance sheets before the 2007–09 financial crises did not reflect the true economic risk these institutions faced and official measures of public debt are typically a significant understatement of vulnerability.
In most countries, the central government public debt have been having an upward mark trend which can be attributed to the ongoing globalization and financial innovation, punctuated by instability caused by periods of financial liberalization and financial repression. As discussed earlier, the degree of deleveraging before the financial crisis has been low for the advanced economies. In essence, the advanced countries have always over utilized their ability and the government’s capacity to finance their activities from the borrowed funds, not only before the crisis, but also after to reinstate their capacity. This strategy likely made only makes the initial post-crisis periods acute. However, this also implies that it may take longer to deleverage.
In conclusion, the reliance of debt restructuring is not the only method of restoring a country from the financial crisis. Admittedly, other approaches as may be agreed by the policy makers may work as well if they are fortunate enough. However, the public debt overhangs that have been experienced over decades during the times of the financial crisis is disheartening. With the increasing need of programs to support the old age, it is evident that there is a desperate need of restructuring. Many advanced countries would not stomach the fact that their public debt exceeds 90% of their GDP especially prior to major financial crisis. Why then should one be ignorant of the negative impact of the financial crisis? As the governments endeavor to ensure economic growth, they should also understand the economic impacts regarding the public debts to avoid its retrogressive elements. The policy makers should consider the impacts of the financial crisis to the peasants in the rural areas whose lives are put to stake. To such low status citizens, the financial crisis which is preventable through better policies means poor living standard and an indirect denial of their basic rights to food, clothing and shelter.
The Financial Crisis & Public Debts Explained In Detail. Accessed on 22nd February 2014 < https://www.youtube.com/watch?v=KSwDxx_zt2Q>