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Deleveraging Effects on Economic Recovery

In: Business and Management

Submitted By mattgibson
Words 2169
Pages 9
Matt Gibson
Professor Moore
The Effects Of Deleveraging
An attempt to decrease the company’s leverage is widely known as deleveraging. If a company pays off any existing debt on its balance sheet, so it is considered as the best way for it to deleverage its sheet and become more liquid. The company may be facing a significant risk of defaults if it fails to pay off its existing debts. Deleveraging can be done both on micro-economic and macro-economic levels. At micro-economic level, decreasing the leverage ratio is known as deleveraging, of a single firm or single economic entity. Moreover, deleveraging on macro-economic level is when there is a reduction in debt levels in private and public sectors. Hence, this leads to a decline in the debt to the GDP ratio in the national account. There are several macro-economic consequences of deleveraging in an economy followed by severe recessions and financial crisis.
According to some studies, deleveraging is considered as the main economic trend for the coming years. However, in contradiction to this, a lot of researchers show that this economic term can prove to be unhelpful.
The most important step to reduce the assets to equity ratio is to reduce the amount of debt held by a company, government or household. This is the first way of cutting leverage. It is important to understand that assets must be reduced as well if the books need to be balanced; hence, not necessarily do assets support some kind of real economic activity. Once there is a lower leverage, there are great chances of reduced risks. The likelihood of default lowers if the equity buffers are bigger. Moreover, lower borrowing costs are the buffer (The Economist 2012).
There are increasing pressures for a period of sustained deleveraging due to the current economic circumstances. Deleveraging is a result of the decline in the assets to equity ratio.

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