The recent stock market booms in Europe and North America share some clear similarities with those in the 1980s and early 1990s as well as with previous historical episodes (see Kindleberger, 2000). The rise in market valuations in advanced countries since the mid-1990s led firms to take advantage of the resulting improvement in balance sheets and lower relative price of debt to borrow and invest well ahead of demand ? some of it finding its way to riskier ventures that were fueled by investors' greater profit expectations and firms' eagerness not to disappoint. These developments have increased corporate vulnerability to a decline in stock prices and aggregate demand, as was typically the case in previous booms. As discussed above, however, some important differences stand out, notably the relatively high post-bubble level of stock market valuations and interest coverage. Also, because the steepest declines in stock market valuations were concentrated in the information technology (IT) sector, which relied more extensively on equity than on debt and was thus generally less leveraged, the repercussions on the domestic banking sector have been more limited. That said, corporate leverage in the United States and Europe remains relatively high and the aggregate corporate financing gap still lies in positive territory, suggesting that these will continue to be a drag on the recovery. This is likely to be more so in Europe for two reasons. One is that, while the United States flow of funds data indicates that deleveraging began in 2002, there is no evidence that this was the case in Europe. Second, the analysis of the determinants of business fixed investment in Box 2.3 shows that corporate investment is typically hampered by high leverage levels during bear markets in both areas, but the impact is typically greater in Europe than the United States. Finally, the leverage problem in all countries would be aggravated if equity markets were to fall further without a concomitant reduction in the real debt burden, something that is more difficult to accomplish in the current low inflation environment (in contrast with the 1970s and much of the 1980s, when higher inflation helped reduce real debt values). Thus, given that a rebound in fixed investment has been a key ingredient of rapid and sustainable recoveries, the process of deleveraging may have to advance somewhat further before a robust recovery is in the offing.
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