March 8, 2021

Economix Blog: How Far Should Consumers Unwind Debt?

In an article today, Tara Siegel Bernard and I examined whether the Fed’s announcement that it would keep credit cheap for two more years would inspire more people to borrow and spend.

Aside from consumer confidence, which is decidedly shaky, a crucial underlying factor holding back borrowing is that families are still paying off debt accumulated during the boom, when credit was easy and people treated their homes like big A.T.M.’s.

According to an analysis from Moody’s Analytics, total household debt peaked in August 2008 at $12.41 trillion and has come down by about $1.2 trillion.

As a proportion of gross domestic product, household debt peaked at 99.5 percent in the first quarter of 2009, and has come down to just under 90 percent.

Economists, who talk about the “deleveraging” process, say that debt still has a way to come down before the economy will return to full health. Just how far it needs to come down, though, is difficult to say.

As recently as 2000, household debt was less than 70 percent of G.D.P., and in 1990 it was around 60 percent.

Kenneth S. Rogoff, a professor of economics at Harvard University and the co-author, with Carmen M. Reinhart, of “This Time Is Different,” a history of financial crises, has repeatedly cautioned that this recovery would take longer than most other recoveries because this recession was caused by a debt-fueled financial crisis.

But even Mr. Rogoff does not have a specific target in mind for how far debt has to decline before households will feel comfortable adding debt again.

It may not have to go as low as it has been in previous decades, he said, because “financial markets deepened and became more sophisticated, and interest rates have been coming down, which allows households to carry higher debt,” Mr. Rogoff said.

He said that studies of financial crises outside the United States have shown that economies generally retrace their steps — in other words, if the ratio of household debt to G.D.P. doubled during the boom that preceded the bust, then the ratio needs to half again in order for the economy to get back to normal consumption patterns.

Whether that would be the case in the United States, Mr. Rogoff said, “I’m hesitant to say.” But, he added, “the overhang of debt really is the major problem for policy makers.” Mr. Rogoff suggests a mix of forgiving some of the housing related debt (perhaps in exchange for homeowners’ giving up gains from future appreciation in their home values) and pursuing a mild inflationary policy.

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