debt, sustainabilityDebt is a mainstay of today’s economy. It allows us to leverage our money when we are flush and get through those times when it is tight. There is a certain level that is needed to keep a nations economy strong, but also a level that once we exceed the results trend negative. I expect that there should be some formula(s) that would provide general guidance for determining these limits.
Are there any recent published works that attempt to address finding this sweet spot?
There is a work of Stein, where he uses a Stochastic Optimal Control technique in order to answer that question in terms of sovereign debt: Stein, J. L. (2006) Stochastic Optimal Control, International Finance, and Debt Crises. Oxford: Oxford University Press.
I hope this could be very helpful to you.
Some DECADES ago, two economists, Merton Miller and Franco Modigliani (who later won a Nobel Prize) tried to calculate the optimal debt level for a corporation, and came up with the unlikely notion that the level of debt “didn’t matter.”
http://en.wikipedia.org/wiki/Modigliani-Miller_theorem
That hasn’t worked in the real world. If it did, then bankruptcy either would not occur, or if it did occur, would be a seamless and painless process. And we know that’s not the case.
Few people have tried to tackle this problem afterward. In a related problem, economist Arthur Laffer created the “Laffer Curve” to try to identify the optimal tax rate.
http://economics.stackexchange.com/questions/126/what-is-the-key-academic-literature-on-impact-of-capital-gains-tax-policy-on-sav/334#334
But “supply side economics” has also largely been discredited.
The basic idea is as follows: Compare the marginal tax benefit of each unit of debt with the marginal increase in distress cost associated for it. Generally each new dollar of debt carries the same benefit as the last, but increasing risk. Keeping borrowing until the cost exceeds the benefit.
For example, if you have a firm (or household) with a million dollars of assets, and want to take find out how much bonds (or mortgage) to take, you would calculate as follows:
Of course the Warren Buffet’s of the world play with much less debt than optimal and find a way to do well, but this is the Corporate Finance 101 answer.
I think this question needs to be rephrased into a positive question. The way it stands, it’s too normative (how things OUGHT to be rather than HOW THINGS work).
I also think “perfect” needs to be made more specific. It means optimal, but optimal in terms of what?
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