American households have been profligate spenders over the last 30 years and have lived beyond their means for too long. Or so it is proclaimed repeatedly in the media and among policy makers. What else could explain the fact that household debt to income ratios have increased while the personal savings rate has fallen?
As it turns out, there are other ways in which debt-income ratios can increase other than actually borrowing more. Specifically, income can grow slower than the real interest burden. The latter in turn depends on both nominal interest rates and inflation. In the case of public debt, there is a long and distinguished literature trying to separate the relevant importance of these effects in periods of leveraging and deleveraging. Interestingly enough, although household debt exceeds public debt substantially (look here at Table L1), there has been virtually no research trying to assess the importance of each channel.
Josh Mason and I have attempted to address this in a new working paper. The basic idea of our paper is to apply the standard equation used to analyze government debt trajectories to the debt of the household sector. We decompose changes in the sector’s debt-income ratio into a primary deficit (i.e. net new borrowing), nominal interest rates, real income growth and inflation. Using this approach, we find some interesting and underappreciated patterns.
In particular, there was no difference in the household sector net new borrowing in the three decades after 1980, when leverage ratios rose sharply, from the prior three decades, when they rose less. There was, however a large increase in household new borrowing in the period 1998-2005 (at the time of the housing bubble). In the 1980s however, households were actually running larger primary surpluses than at any time before or after. Virtually the entire rise in household debt in that period, and a significant fraction of the rise in the 2000s, can be attributed to higher effective real interest rates and not net new borrowing.
Where did this sea-change come from? Our working hypothesis is that a political economy shift in favor of financial capital (what may be termed the move towards financialization or rentier neoliberalism) occurred beginning around 1980. The beginning of the decade saw sharp rises in real interest rates with the Volcker shock and subsequent disinflation in the economy. In addition, deregulation of interest rates and a rising importance of the financial sector both economically and politically also contributed towards changing debtor-creditor relations. Although interest rates fell, inflation rates fell even more.
How important were these changes for household debt-income ratios? The figure below drawn from our paper is suggestive. It depicts the actual household debt-income ratio trend from 1945-2010, and a counterfactual trajectory if the growth rate of income, inflation rate and nominal interest rate was the average of the period from 1945-1980. The ‘profligacy of the American household’ looks fairly muted in the light of the alternative history.
We found several more interesting patterns in the paper, which we’re hoping you’ll take a look at. In particular, it is really useful to take a look at household debt trajectories in historical context. At the current juncture, we are updating and revising the piece, so any helpful input, thoughts and comments would be very much appreciated.
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