Debt, Financial Stability, and Public Policy

Most major types of debt have grown rapidly in recent years. The most publicized aspect of the overall growth in debt has been the unprecedented size of federal government budget deficits. But debt of households and businesses has also grown rapidly, and the debt of developing countries has risen so much that exceptional efforts by international lending agencies, creditors in developed countries, and the developing countries themselves have been required to prevent widespread defaults. The buildup in debt could imperil the stability of the financial system, according to some analysts. They argue that the heavy debt burdens have reduced the ability of financial institutions, borrowers, and the economy at large to withstand recessions and other types of adversity. The resulting increase in financial fragility could force the Federal Reserve to choose between financial stability and price stability as the primary goal of monetary policy. Several changes in public policy have been recommended to alleviate the effects of the high level of debt. Reform of tax laws, regulatory policies, and financial disclosure requirements-as well as changes in the government's fiscal policy-have been advocated as ways of reversing what has been called "the leveraging of America. " To gain a better understanding of the possible threats to financial stability from the buildup in debt, the Federal Reserve Bank of Kan-