2007 TheRiseinUSHouseholdIndebtednes
- (Dynan & Kohn, 2007) ⇒ Karen Dynan, and Donald Kohn. (2007). “The Rise in US Household Indebtedness: Causes and Consequences.” FEDS Working Paper.
Subject Headings: US Household Debt, US Household Debt to Income Ratio, US Personal Saving Rate.
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1. Introduction
During the past several decades in the United States, significant changes have occurred in household saving and borrowing behavior. As shown in the top panel of Figure 1, the personal saving rate has fallen from an average of 9.1 percent in the 1980s to an average of 1.7 percent so far this decade. Between the same periods, the ratio of total household debt to aggregate personal income, shown in the bottom panel, rose from 0.6 to 1.0. In this paper, we consider the causes and consequences of the dramatic increase in household indebtedness. Clearly the issues surrounding household borrowing are closely related to those surrounding household saving. However, the borrowing perspective is relatively underexplored, and we think it is particularly interesting at the present time given the rapid pace of mortgage debt accumulation in recent years.
We focus first on the factors explaining the rise in household debt. Using simple models of household behavior as our guide, we empirically explore the likely contributions of a wide range of factors. Changes in tastes, interest rates, and households’ expected incomes do not appear to have materially increased household borrowing, but demographic shifts can explain part of the run-up in debt. The increase in house prices — particularly, but not exclusively, over the past half-dozen years — appears to have played the central role. House prices can be linked to household borrowing through several different channels; distinguishing among them is difficult, although we present some suggestive evidence. Financial innovation also seems to have boosted debt, not primarily by increasing the share of households that are able to borrow but by increasing the amount of debt held by households that already had some access to borrowing.
We then turn to the consequences of higher household debt. For monetary policy-making, the key issue is whether greater indebtedness has affected the sensitivity of household spending to various economic shocks. U.S. households have become more exposed to shocks to asset prices through the greater leverage in their balance sheets; a given change in stock prices or home prices will have a larger effect on net wealth and so on spending. With regard to income and interest rate shocks, forces push in opposite directions. On the one hand, households’ discretionary cash flow has become more sensitive to such shocks because of the increased share of their incomes devoted to debt service. On the other hand, the greater availability of credit makes it easier for households to smooth through temporary downturns in income, and the rapid rise in household assets means that net worth has risen considerably relative to income despite the run-up in debt. Empirical work suggests that, on average, U.S. households have become less sensitive to shocks to their in come, but this result should not be taken as generalizing to every situation or every type of household. Of particular note, households in the upper tail of the distribution of the ratio of debt to assets are more likely to be insolvent than in the past and more likely to face financial strain. As illustrated by the recent developments among subprime mortgage borrowers, excessive accumulation of debt can, in some circumstances, lead to financial distress. Moreover, the reaction of financial markets to these developments raises the possibility that credit availability could be hampered for a larger group of households, which could, in turn, have effects on the broader economy.
Factors Influencing Household Debt
In a world with no borrowing constraints, house holds choose a path for consumption based on their expected lifetime resources, interest rates, and tastes. Given some level of income at any point in time, the consumption choice immediately implies a level of saving. Households also choose their portfolio allocation, determining the amounts they hold of different types of assets and liabilities consistent with their net worth. These decisions are determined by households’ risk preferences, market rates of return, tax provisions, and other factors. If incomes rise over time until retirement, as they typically do, households in this constraint-free world tend to borrow, on net, when young, move into positive net worth as they age, and then run down their net worth in retirement.
Figures
- Figure 1 - The Evolution of Household Saving and Debt in the United States
File:US-Annual-Personal-Saving-Rate-1980-to-2006.jpg
File:US-Household-Debt-to-Personal-Income-Ratio-1980-to-2006.jpg.
References
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| Author | volume | Date Value | title | type | journal | titleUrl | doi | note | year | |
|---|---|---|---|---|---|---|---|---|---|---|
| 2007 TheRiseinUSHouseholdIndebtednes | Karen Dynan Donald Kohn | The Rise in US Household Indebtedness: Causes and Consequences | 2007 |