As you may know, the financial market is made up of various monetary flows. This also includes the conditions of debt within that country, as the people make up the fundamental body of the country’s economy. As a result, when the people in the nation are in debt, it is safe to say that the economy is not doing well. Further, this also affects the economies of other nations.
What does a debt crisis look like?
If a country is unable to pay creditors the money that the government has borrowed, it is said to be in a debt crisis. They may borrow for several reasons, including large national programs or projects. Once the tax revenue earned from the citizens is no longer enough for repayment, the economy starts to suffer a downturn.
For instance, during high debt conditions in a country, interest rates usually start to spike. The trading, stocks and the financial market start to slow down as people start experiencing a decline in consumer confidence. As the buying power of the public is reduced, the economy begins.
How does the debt crisis impact the economy?
To understand this better, We first need to know about Modern Monetary Theory. This is the notion that a country that is financially sovereign will have no constraints on the amount they are able to spend. However, this is simply not true in praxis. No matter how monetarily sovereign a nation may be, it will always have spending restrictions. This is because you cannot spend and invest more than what the country produces. Failing to heed this causes a debt crisis, which can manifest in 4 major growth stoppers for the economy:
- Transfers: Rising debt will always create an ex-ante or predicted disparity between demand and supply. This disparity is usually adjusted by transferring income from one sector of society to another. This can have a detrimental impact on the growth of the country as the economy and its flows are completely distorted.
- Bezzle: The increasing rise of debt is ripe for the creation of fictional wealth or the promise of money that does not actually exist. This is known as bezzle. These include inflation, unreachable price hikes and industries capitalizing on assets that need to be expensed more evenly.
- Financial distress: When the economy is under monetary stress, it can cause some sectors to start behaving in unpredictable ways in order to protect themselves from being absorbed into the cost of the debt. These unpredictable conditions increase financial fragility.
- Hysteresis: This is when the process of adjusting to the debt conditions in the economy leads to more costs of adjustment. For instance, let’s say a government is trying to get out of debt, which triggers a major financial crisis in the nation. This can lead to an immense political crisis.
In essence, when two or more of these outcomes are triggered at the same time, it causes significant job losses, political upheavals and distress in the country, which leads to the slowing down of economic growth.
Conclusion
When a country goes into a debt crisis, the cost of goods and other services keeps rising. There are higher interest rates on everything, including personal loans, mortgages, etc. In such conditions, I always advise that you try to get out of any potential cycles of debt. Debt consolidation can come in handy by preventing you from drawing further loans while rolling all your existing debts into a single account with one interest rate.
The best way to keep your financial health in check is to avoid debt as much as possible. While it can be difficult in times of crisis, debt repayment strategies can help.
