Household debt: An Alternative to the Wikipedia View

All of the Wikipedia references in this essay have been taken from the "Household debt" article on the evening of 9 April 2021.

 The opening statement:

Household debt is defined as the combined debt of all people in a household. It includes consumer debt and mortgage loans. A significant rise in the level of this debt coincides historically with many severe economic crises and was a cause of the U.S. and subsequent European economic crises of 2007–2012. Several economists have argued that lowering this debt is essential to economic recovery in the U.S. and selected Eurozone countries.

"A significant rise in the level of this debt" -- household debt, as opposed to government debt, nonfinancial business debt, and financial business debt -- "coincides historically with many severe economic crises..."

I am particularly uncomfortable with the view that household debt is the problem. Such analysis is, at the very least, oversimplified.

 

Under Historical perspective:

In the 20th century, spending on consumer durables rose significantly... Easy credit encouraged a shift from saving to spending.

No. Policy encouraged the shift from saving to spending; easy credit was only one aspect of policy.

Under Global economic impact:

"Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent...

Yeah, okay. I don't know the specific percentages, but rapid debt increase leading up to 2007 is right. On the other hand, it is wrong to grab one fact and start drawing conclusions. Just as the financial crisis and Great Recession were consequences of massive, rapidly growing household debt, so too was the massive and growing household debt a consequence of that which came before.

We cannot wait until the shit hits the fan and then say Now there's the problem! We must not wait until it is too late. If accumulating debt leads to accumulating disaster, the time to act is not at the first evidence of disaster but at the first indication that growing debt is starting to slow the economy. Not in 2007, in other words, but in 1967.

Under U.S. economic impact: 

The policy prescription of Ms Yellen's predecessor Mr Bernanke was to increase the money supply and artificially reduce interest rates. This stoked another debt and asset bubble.

Note carefully that those sentences attribute both the solution and the problem to the central bank.

The central bank operates in an economic environment created largely by the U.S. Congress. The U.S. tax code for many many years, by allowing the tax deduction for interest paid, encouraged people to go into debt and to remain in debt. Only when debt had grown to the point that it was creating problems did Congress begin to eliminate the tax deduction. It was half-hearted. It was ill-conceived. And it came too late.

Eliminating the tax deduction at a time when debt was already creating problems only made the problems more severe. You would have had to eliminate the deduction by the early 1960s to beat the clock on this, and the fact that you don't believe that is part of the reason it didn't happen.

In any event it would have been better to replace the tax deduction for interest paid with a tax credit that reduces our tax payments when we pay down our debt ahead of schedule. Such a policy could be designed to create the same tax advantage for the taxpayer, while improving macroeconomic conditions by reducing our debt.

And this:

Economists Atif Mian and Amir Sufi wrote in 2014 that:

• Historically, severe economic downturns are almost always preceded by a sharp increase in household debt.

Again, we don't want to wait until the severe economic downturn is right on top of us.

And again, looking only at household debt gives us an incomplete picture. Here is household debt as a percent of GDP:

Graph #1: Household Debt as Percent of GDP

On the first graph, household debt appears to reach a horrifying high just in time to cause the Great Recession. But now look at that same household debt as a percent of All Sectors debt:

Graph #2: Household Debt as Percent of All Sectors Debt

Relative to the big debt number, household debt reaches its lowest peak just before the Great Recession. High peaks occurred in the mid-1960s when the economy was still good, but on the cusp, and in 1980 when the economy was already slowing due to excessive debt.

Look only at household debt and household debt looks like the biggest problem in the world. Compare household debt to all the debt, and you know in your bones that the problem does not lie in one piece of our massive accumulation of debt, but in the whole of it.

Under Effects on economic growth they quote Ezra Klein:

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 ...

Number one: IT CANNOT BE DONE THROUGH CONVENTIONAL POLICY. Conventional policy is based on two notions, one true, one false:

• using credit is good for growth; and 
• the resulting debt does no harm.
  

The problem will not be solved by conventional policy until the conventions change. 

And remember, if the problem is debt, look at the whole problem, not just part of it. And when the problem is big enough to grab everyone's attention, the economy is telling you the problem has been growing worse for a very long time.