Josh Mason and Arjun Jayadev have a new working paper on the evolution of U.S. household debt, and Mason has written a blog post summarizing their findings:
It’s a well-known fact that household debt has exploded in recent decades, rising from 50 percent of GDP in 1980 to over 100 percent on the eve of the Great Recession. It’s also well-known that household borrowing has increased sharply over this period. Indeed, for most people — including many economists — these are two ways of saying the same thing. In fact, though, they are quite different claims, and while the first one is certainly true, the second is not.
So what’s going on, exactly? As Mason goes on to explain, it turns out that rising household debt levels flow from the Volcker-era conquest of inflation.
If interest rates, growth and inflation over 1981-2011 had remained at their average levels of the previous 30 years, then the exact same spending decisions by households would have resulted in a debt-to-income ratio in 2010 below that of 1980, as shown in Figure 2. The 1980s, in particular, were a kind of slow-motion debt-deflation, or debt-disinflation; the entire growth in debt relative to earlier periods (17 percent of household income, compared with just 3 percent in the 1970s) is due to the slower growth in nominal income as a result of falling inflation. In other words, there is no reason to think that aggregate household borrowing behavior changed after 1980; indeed households rescued their borrowing in the face of higher interest rates just as one would expect rational agents to. The problem is that they didn’t, or couldn’t, reduce borrowing fast enough to make up for the fact that after the Volcker disinflation, leverage was no longer being eroded by rising prices.
This complicates some of the familiar narratives surrounding the increase in household debt:
Neither the 1980s nor the 1990s saw an increase in new household borrowing — on the contrary, the household sector in the aggregate showed a primary surplus in these decades, in contrast with the primary deficits of the postwar decades. So both the conservative theory explaining increased household borrowing in terms of shorter time horizons and a general lack of self-control, and the liberal theory explaining it in terms of efforts by those further down the income ladder to maintain consumption standards in the face of a falling share of income, need some rethinking. Given the increased availability of credit and rising inequality, some households may well have chosen to increase spending relative to income, and those lower down the income ladder presumably did rely on borrowing to maintain consumption standards in the face of stagnant wages. But for the household sector in the aggregate, until 2000, there is no increased household borrowing to explain.
During the housing bubble, Mason explains, there was an increase in borrowing, but debt dynamics still accounted for a third of the increased in debt.
Mason and Jayadev conclude that it will be very difficult to alleviate the increase in household debt through belt-tightening:
[G]oing forward, it seems unlikely that households can sustain large enough primary deficits to reduce or even stabilize leverage. Even the very large surpluses of 2006-2011 would not have brought down leverage at all in the absence of the upsurge in defaults; and in the absence of large federal deficits and an improving trade balance the outcome would have been even worse since reductions in household expenditure would have reduced aggregate income. As a practical matter, it seems clear that, just as the rise in leverage was not the result of more borrowing, any reduction in leverage will not come about through less borrowing. To substantially reduce household debt will require some combination of financial repression to hold interest rates below growth rates for an extended period, and larger-scale and more systematic debt write-downs.
It’s a fascinating argument. The following is drawn from the paper’s conclusion:
While growing out of debt would be ideal, it would require a large increase in net exports, government spending and/or private investment, none of which seems plausible for the US at present.
This serves as a reminder of the importance of “global rebalancing,” an idea that we tend to think of narrowly (e.g., in the context of China’s currency peg) if at all but which strikes me as absolutely central, particularly if you’re inclined to the Michael Pettis view that (a) the role of the U.S. dollar as the world’s primary reserve currency has outlived its usefulness for the U.S. and that (b) the China’s investment-driven growth model is about to sputter under the weight of bad debts.
I might be more sanguine than Mason and Jayadev about the prospects for a large increase in net exports and private investment. But their argument merits wide attention.