debt crisis

debt crisis, a situation in which a country is unable to pay back its government debt. A country can enter into a debt crisis when the tax revenues of its government are less than its expenditures for a prolonged period.

In any country, the government finances its expenditures primarily by raising money through taxation. When tax revenues are insufficient, the government can make up the difference by issuing debt. That is done primarily by selling government treasury bills in the open market to investors.

A government with a good reputation and little debt or an established track record of paying back what it has borrowed usually does not face much difficulty in finding investors who are willing to lend to it. However, if the debt load of a government becomes too large, investors begin to worry about its ability to pay back, and they start demanding higher interest rates to compensate for the higher risk. That results in an increase in the cost of borrowing for that government. As investor confidence deteriorates further over time, pushing the cost of borrowing to higher levels, the government may find it more and more difficult to roll over its existing debt and may eventually default and enter into a debt crisis.

Many countries have experienced debt crises. Examples include the Latin American debt crisis of the 1980s, which resulted in a “lost decade” for the region, and the European sovereign debt crisis beginning in 2009.