The Increase in Household Debt Prior to the Crisis is Not a Moral Issue

http://economistsview.typepad.com/economistsview/2012/02/the-increase-in-household-debt-prior-to-the-crisis-is-not-a-moral-issue.html

Friday, February 24, 2012

Via Mike Konczal at Rortybomb, Josh Mason explains the findings of his research with Arjun Jayadev on the dynamics of household debt. Importantly, this research knocks a hole in the story that it was lack of self control -- the decline of the morals of the middle class -- that caused the increase in household debt prior to the financial crisis (the original article also has the mathematics and empirical tables explaining and documenting the results):

Guest Post by JW Mason: The Dynamics of Household Debt: [Mike here. ... Josh Mason ... and Arjun Jayadev, former Roosevelt Institute fellow and economist at Umass-Boston, have an interesting new paper out on the growth of household debt over the past 30 years. I asked them if they would write a summary of this research..., and Josh was willing...]

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. ... In fact, though,... while the first one is certainly true, the second is not.

How can debt have increased if borrowing hasn’t? Though this seems counterintuitive, the answer is simple. We’re not interested in debt per se, but in leverage, defined as the ratio of a sector’s or unit’s debt to its income (or net worth). This ratio can go up because the numerator rises, or because the denominator falls. Household leverage increased sharply, for instance, in 1930 and 1931 (see Figure 1) but people weren’t were consuming more in the Depression; leverage rose because incomes and prices were falling faster than households could pay down debt. Similarly, changes in interest rates can change the debt burden without any shift in household consumption...

But strangely, despite the example of the Depression (and Irving Fisher’s famous diagnosis of rising debt burdens caused by falling prices and incomes (Fisher 1933)), no one has systematically examined what fraction of changes in private debt can be attributed to changes in interest, growth, inflation and new borrowing. In a new paper, Arjun Jayadev and I attempt to fill this gap, applying the standard decomposition of public sector debt changes to household debt in the United States for the period 1929-2011. (Mason and Jayadev, 2012.) Our findings challenge the conventional narrative about rising household debt.

What we find is that the entire increase in household leverage after 1980 can be attributed to the non-borrowing... — what we call Fisher dynamics. 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.

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