How Does a Debt Crisis Happen?

When a country faces the prospects of being unable to make good on its outstanding debts, this is a debt crisis. The effects of a debt crisis can be severe. It can downgrade the country's credit rating, making it harder to borrow money, and it may force the country may to slash services. A number of factors can cause debt.

History

Many countries have suffered debt crisis throughout history. In the early 1980s, a number of Latin American countries, which took on a heavy debt burden in the preceding decade to finance infrastructure development, found they were unable to repay their debt owed to Western nations. More recently, in 2010, Greece faced a danger of default after officials discovered the debts were much larger than realized, precipitating a bailout by the European Union.

Features

The definition of a debt crisis is when a country has significant enough debt that it is in imminent danger of defaulting, if it has not done so already. For a debt crisis to happen, the country must have taken out a significant amount of loans. In many cases, this may have been in good faith, with the belief that the country could pay it back.

Causes

A debt crisis can result from many causes. In the case of Latin America, the increase in the size of the economy was not enough to match the interest payment on the loans. When interest rates rose, many countries were unable to service their debt successfully. In the case of Greece, the government expanded social services to a point where it was no longer able to pay for them.

Effects

As with debt taken on by individuals, government debt can often spiral out of control. As the government attempts to pay the interest on its loans, the country becomes unable to provide the kinds of services required to increase revenues. This causes the debt to go unpaid, meaning interest on the debt increases, pushing the country even deeper into debt.

Solution

There are a number of ways to stem a debt crisis. In some cases, to prevent the country from going broke, lenders may write off all or part of the debt. In other cases, other countries may bail out the nation, as a number of European countries bailed out Greece. The debtor country can then eventually repay the loan under more favorable terms.