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Predicting Financial Crises: Debt versus Debt Service Ratios

Author

Listed:
  • Steve Ambler

    (University of Quebec in Montreal, C.D. Howe Institute)

  • Jeremy Kronick

    (C.D. Howe Institute)

Abstract

Canada is often cited as having worryingly high credit-to-GDP and credit-to-disposable-income ratios, in spite of the fact that the assets and net worth of Canadian households have grown more quickly than their debt. We show that the level of debt servicing is a more reliable indicator of financial vulnerability than the level of debt itself. First, we construct a new financial vulnerabilities barometer and show that measures of debt servicing improve its ability to track periods of financial vulnerability, particularly in advance of recessions. Then, we show that the debt service ratio is a better predictor than the debt ratio of future declines in economic activity and banking crises. New borrowing, while supportive of economic growth in the short run, leads to an increase in debt servicing which contributes to slumps in economic activity.

Suggested Citation

  • Steve Ambler & Jeremy Kronick, 2020. "Predicting Financial Crises: Debt versus Debt Service Ratios," Working Papers 20-09, Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management.
    • Handle: RePEc:bbh:wpaper:20-09
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    References listed on IDEAS

    as
    1. Mathias Drehmann & Mikael Juselius, 2012. "Do debt service costs affect macroeconomic and financial stability?," BIS Quarterly Review, Bank for International Settlements, September.
    2. Drehmann, Mathias & Juselius, Mikael, 2014. "Evaluating early warning indicators of banking crises: Satisfying policy requirements," International Journal of Forecasting, Elsevier, vol. 30(3), pages 759-780.
    3. Drehmann, Mathias & Juselius, Mikael & Korinek, Anton, 2017. "Accounting for debt service: The painful legacy of credit booms," Bank of Finland Research Discussion Papers 12/2017, Bank of Finland.
    Full references (including those not matched with items on IDEAS)

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