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For US and global economies, debt is a four-letter word

It's hard to conclude anything else: Debt – owed by households, governments, and banks – lies at the heart of the economy's troubles. Even after two years of recovery, debt remains a big drag.

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The debt burdens don't halt US growth outright. The economy appears to be expanding at an annual pace of about 2 percent. The problem is, that hasn't been fast enough to bring unemployment down significantly, because the labor force is growing and so is worker productivity. And the tepid growth leaves the economy vulnerable to a recession if a new head wind arises.

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A recent Heartland Monitor poll found some 47 percent of borrowers saying the downturn has encouraged them to pay off debt or not take on new debt, even if that means spending cutbacks. And since the recession began, the amount of income that households must devote to monthly debt payments has fallen from 14 percent of income to 11 percent. "It's like having 3 percent more income to spend," says Karen Dynan, an economist at the Brookings Institution in Washington.

By other measures, millions of families still have a long way to go. Despite all the defaults and foreclosures in the past four years, total mortgage debt today is nearly $10 trillion, down only 6 percent from its peak year of 2007.

So what can be done? Some leading policy options would target mortgages and the housing market directly.

President Obama recently announced changes in a program to reduce monthly payments for at-risk homeowners. The goal is to offer refinancing to some of the 11 million borrowers who owe more than their homes are worth. Moody's Analytics estimates that the new "refi" push could help 1.6 million households, bringing the total served by Mr. Obama's Home Affordable Refinance Program to 2.85 million.

Some economists call for more aggressive re-financing, or new incentives to bring buyers into the housing market – whether as occupants or landlords.

Sufi, at the University of Chicago, says he supports considering ambitious plans. He also cautions against viewing any as a quick fix.

In fact, by some estimates a large-scale refinancing effort might allow GDP to grow about half a percentage point faster – helpful, but still not an enormous benefit.

That means policymakers might need to consider a range of other policies to get the recovery back on track:

•The Federal Reserve could attempt more unconventional means to pump monetary fuel into the economy, although economists are divided over whether such an effort would work.

•On fiscal policy, a credible long-term plan to reduce US budget deficits could be a confidence boost for consumers and businesses, while not necessarily causing a big immediate plunge in federal spending.

•Other moves might help the economy grow faster regardless of how long the debt drag lasts. Streamlining the tax code or taking steps to promote innovation are examples.

Even small successes could be important, helping the economy achieve what Bethune calls "escape velocity." The more jobs and incomes grow, the easier it will be for debtors and home prices to revive.

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