Predicting Financial Crises: Debt versus Debt Service Ratios

Steve Ambler and Jeremy Kronick
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Steve Ambler: University of Quebec in Montreal, C.D. Howe Institute

No 20-09, Working Papers from Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management

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.

Pages: 37 pages
Date: 2020-05
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Journal Article: Predicting financial crises: debt versus debt service ratios (2023)
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