BTL 874 - Doom Loop

 

The Banking Tutor’s Lessons

BTL 874                                                                                27-02-2026

Doom Loop

A Doom Loop describes a situation in which one negative economic condition creates a second negative condition, which in turn creates a third negative condition or reinforces the first, resulting in a downward spiral.

A "Doom Loop" in economics is a self-reinforcing, destructive cycle where negative feedback loops, typically between a country's banking system and its sovereign debt, trigger a downward spiral of financial instability.

It occurs when weakened banks hold government bonds, and falling bond prices - often caused by sovereign debt risks - cripple bank balance sheets, necessitating bailouts that further deteriorate government finances, creating a vicious circle.

The term draws from the broader concept of doom loops, in which a negative factor triggers another, which then triggers another or exacerbates the original negative factor, creating a vicious cycle. The term "doom loop" was popularized in the 2001 management book "Good to Great" by Jim Collins.

Key Aspects of Economic Doom Loops:

Sovereign-Bank Nexus: Banks often hold large amounts of their own government's debt. If the government’s creditworthiness drops, the value of these bonds falls, hurting the banks. To prevent bank failure, the government may bail them out, further increasing its debt and weakening its fiscal position, which in turn hurts the banks further.

Macroeconomic Factors: High government debt levels, lack of fiscal discipline, and financial sector vulnerability are primary drivers.

Impact: Such loops can lead to severe economic contractions, reduced bank lending (credit crunch), and potential sovereign default.

A flywheel is a mechanical device that uses momentum to store energy. Once the heavy wheel gets moving, its own weight and momentum keep it moving with minimal to no effort. Conceptually, it is the opposite of a doom loop.

The term “flywheel effect” was also popularized in the book "Good to Great." According to Collins, corporate turnarounds and startup success stories are the result of an ongoing process of slow and steady progress. Collins likened this to the slow but steady increasing speed of a flywheel as it gains enough momentum to continue spinning on its own or with minimal effort

Breaking a doom loop usually requires significant structural reforms, such as reducing the exposure of banks to their own sovereign debt or implementing stricter fiscal policies.

Sekhar Pariti

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