Page 42 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE, V.72, # 1, 2015, pp. 40-49

requirements for debtors and so decrease the lending. Thus the reluctance of both

firms to borrow and banks to lend may be overcome by profit participating financing.

We start in this paper with a description of how debt crises occur. We then

show that Japanese crisis is caused by debt rigidity. Then it is argued that because of

debt rigidity banking sector in US and euro area is also vulnerable to crisis.

Debt rigidity as the cause of debt crises

Why do debt crises take place? It is obviously that debt crisis is the inability of

debtors to fulfill obligations to creditors. There are some reasons why debtors face

debt problems. Among them decline in asset prices, "malinvestment" induced by

credit boom, using of short-term debts for long-term assets can be shown.

Description of how debt crisis occurs is suggested by Minsky (Minsky,1980).

According to Minsky at the beginning of the boom phase of the business cycle firms

in order to finance their investment projects use mostly internal financing, while the

role of loans is low. The companies‘ incomes allow them to repay the interest on the

loan and principal. With the growth of the economy and favorable forecasts firms

are beginning to step up investment and firms are actively moving to external

financing of capital investments. After a while there comes a situation where

incomes of many firms are sufficient only for the payment of interest, but they

cannot repay the principle. Such firms need to issue new debt to meet commitments

on maturing debt. In case of rising interest rates or reduction of incomes firms

cannot fulfill either the repayment of principle or the interest on debts. Such units

can borrow or sell assets to pay interest. But borrowing to pay interest increases

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