Free Essay On Economics - Debt
According to Investopedia.com, debt is an amount of money borrowed by one party from another. Any country, company or individual may be a borrower or lender. Debt burden is quite similar term, but the connotation of these two varies. Debt burden is the amount of debt that a borrower is unable to repay, thus this debt has become ominous for him. Such a situation may occur due to such factors as inflation\deflation of national currency or fluctuations on the capital markets.
Deflation is defined as a fall in the general price level. Some argue whether its impact on the national economics is good or bad. But, for sure, deflation is undesirable for borrowers on national currency. Deflation leads to difficulties in servicing debt denominated in national currency, as the real value of the debt (as well as the currency itself) every year may be increased. Eventually, households and companies have to spend a larger percent of their income on paying off the debt. Less money is substantially spent on investment. All these are prerequisites of economic downturn, such as those experienced in the 1920s and 1930s.
In order to clarify the mechanism, I would like to show a simple example of farmer household in 1920s. In spring a farmer takes a loan of $1000 in order to start sowing, provided that interest rates are 10%. This means by the next spring this farmer must pay off $1100. Then, is a result of economic recovery the inflation rates go below zero (this means the process of deflation). Wheat prices fall from $50 per sack (we talk about ordinary farmer, so I would not think in terms of futures) to $40 per sack. This means lower income and increased debt burden for this particular farmer. Why? Because now he needs to sell 28 sacks of wheat in order to cover the debt instead of 22 prior to deflation. His debt became more expensive. On the other hand, if a debt is denominated in foreign currency, the borrower benefits from deflation. The value of his or her debt becomes lower.