Household Debt - U.S. Economic Impact

U.S. Economic Impact

This increase in debt during the 1980-2007 period enabled spending that stimulated the economy, arguably "papering over" or hiding the sustainable economic growth rate excluding this increase in leverage. This debt overhang then began holding back the economy as consumers paid down debt (which reduces economic activity) rather than spend.

Paul Krugman wrote in December 2010: "The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble. Twenty years ago, the average American household’s debt was 83 percent of its income; by a decade ago, that had crept up to 92 percent; but by late 2007, debts were 130 percent of income. All this borrowing took place both because banks had abandoned any notion of sound lending and because everyone assumed that house prices would never fall. And then the bubble burst. What we’ve been dealing with ever since is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years. This would be fine if someone else were taking up the slack. But what’s actually happening is that some people are spending much less while nobody is spending more — and this translates into a depressed economy and high unemployment. What the government should be doing in this situation is spending more while the private sector is spending less, supporting employment while those debts are paid down. And this government spending needs to be sustained: we’re not talking about a brief burst of aid; we’re talking about spending that lasts long enough for households to get their debts back under control. The original Obama stimulus wasn’t just too small; it was also much too short-lived, with much of the positive effect already gone."

During April 2009, U.S. Federal Reserve Vice Chair Janet Yellen discussed the situation: "Once this massive credit crunch hit, it didn’t take long before we were in a recession. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged. Indeed, we have been in the grips of precisely this adverse feedback loop for more than a year. A process of balance sheet deleveraging has spread to nearly every corner of the economy. Consumers are pulling back on purchases, especially on durable goods, to build their savings. Businesses are cancelling planned investments and laying off workers to preserve cash. And, financial institutions are shrinking assets to bolster capital and improve their chances of weathering the current storm. Once again, Minsky understood this dynamic. He spoke of the paradox of deleveraging, in which precautions that may be smart for individuals and firms—and indeed essential to return the economy to a normal state—nevertheless magnify the distress of the economy as a whole."

Ezra Klein wrote in August 2011: "hat distinguishes crises like this one from typical recessions is household debt. When the financial markets collapsed, household debt was nearly 100 percent of GDP. It’s now down to 90 percent. In 1982, which was the last time we had a big recession, the household-debt-to-GDP ratio was about 45 percent. That means that in this crisis, indebted households can’t spend, which means businesses can’t spend, which means that unless government steps into the breach in a massive way or until households work through their debt burden, we can’t recover. In the 1982 recession, households could spend, and so when the Federal Reserve lowered interest rates and made spending attractive, we accelerated out of the recession. The utility of calling this downturn a “household-debt crisis” is it tells you where to put your focus: you either need to make consumers better able to pay their debts, which you can do through conventional stimulus policy like tax cuts and jobs programs, or you need to make their debts smaller so they’re better able to pay them, which you can do by forgiving some of their debt through policies like or eroding the value of their debt by increasing inflation. I’ve heard various economist make various smart points about why we should prefer one approach or the other, and it also happens to be the case that the two policies support each other and so we don’t actually need to choose between them. All of these solutions, of course, have drawbacks: if you put the government deeper into debt in order to help households now, you increase the risk of a public-debt crisis later. That’s why it’s wise to pair further short-term stimulus with a large amount of long-term deficit reduction. If you force banks to swallow losses or face inflation now, you need to worry about whether they’ll be able to keep lending at a pace that will support recovery over the next few years. But as we’re seeing, not doing enough isn’t a safe strategy, either."

Rana Foroohar wrote in July 2012: "esearch shows that the majority of job losses in the U.S. since the Great Recession were due to lower consumer spending because of household debt, a decline that resulted in layoffs at U.S. firms. Parting back debt is the precursor to greater spending and greater growth."

Economist Amir Sufi at the University of Chicago argued in July 2011 that a high level of household debt was holding back the U.S. economy. Households focused on paying down private debt are not able to consume at historical levels. He advocates mortgage write-downs and other debt-related solutions to re-invigorate the economy when household debt levels are exceptionally high. Several European countries also had high household debt levels relative to historical averages leading up to the European debt crisis. Recent research also supports the view that excessive household leverage has contributed to the weakness in consumption.