Context
- There is a risk that Britain’s economy could end up in a “doom loop”.
What is Doom Loop?
- The doom loop is the circle of vulnerability where a country’s banking system can be severely hurt by volatility in the price of the sovereign bonds they hold for reserves resulting in a contraction in lending provided by the banks.
- This contraction in credit, in turn, slows the domestic economy, resulting in a further deterioration in the price of the sovereign’s bond issues as the government is forced to increase its borrowing to maintain services in a period when tax receipts are falling.
- The loop can also begin with the banking sector if a contraction in bank lending due to liquidity or non-performing loan problems sparks volatility in the government bond prices by slowing the economy and eroding confidence in the sovereign credit.
- The circle can also be activated by external forces such as a slowdown in global economic activity due to natural recession or trade friction
Source: ET
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