The Christmas and new year period often draws attention to the financial well-being of households. An important determinant of this is the extent of their indebtedness. Rising levels of debt mean that increasing amounts of households’ incomes becomes prey to servicing debt through repayments and interest charges. They can also result in more people becoming credit constrained, unable to access further credit. Rising debt levels can therefore lead to a deterioration of financial well-being and to financial distress. This was illustrated starkly by events at the end of the 2000s.
The total amount of lending by monetary financial institutions to individuals outstanding at the end of October 2018 was estimated at £1.61 trillion. As Chart 1 shows, this has grown from £408 billion in 1994. Hence, indivduals in the UK have experience a four-fold increase in the levels of debt. (Click here to download a PowerPoint of the chart.)
The debt of individuals is either secured or unsecured. Secured debt is debt secured by property, which for individuals is more commonly referred to as mortgage debt. Unsecured debt, which is also known as consumer credit, includes outstanding debt on credit cards, overdrafts on current accounts and loans for luxury items such as cars and electrical goods. The composition of debt in 2018 is unchanged from that in 1994: 87 per cent is secured debt and 13 per cent unsecured debt.
The fourfold increase in debt is taken by some economists as evidence of financialisation. While this term is frequently defined in distinctive ways depending upon the content in which it is applied, when viewed in very general terms it describes a process by which financial institutions and markets become increasingly important in everyday lives and so in the production and consumption choices that economists study. An implication of this is that in understanding economic decisions, behaviour and outcomes it becomes increasingly important to think about the potential impact of the financial system. The financial crisis is testimony to this.
In thinking about financial well-being, at least at an aggregate level, we can look at the relative size of indebtedness. One way of doing this is to measure the stock of individual debt relative to the annual flow of GDP (national income). This is illustrated in Chart 2. (Click hereto download a PowerPoint of the chart.)
The growth in debt among individuals owed to financial institutions during the 2000s was significant. By the end of 2007, the debt-to-GDP ratio had reached 88 per cent. Decomposing this, the secured debt-to-GDP ratio had reached 75 per cent and the unsecured debt-to-GDP ratio 13 per cent. Compare this with the end of 1994 when secured debt was 46 per cent of GDP, unsecured debt 7 per cent and total debt 53 per cent. In other words, the period between 1994 and 2007 the UK saw a 25 percentage point increase in the debt-to-GDP ratio of individuals.
The early 2010s saw a consolidation in the size of the debt (see Chart 1) which meant that it was not until 2014 that debt levels rose above those of 2008. This led to the size of debt relative to GDP falling back by close to 10 percentage points (see Chart 2). Between 2014 and 2018 the stock of debt has increased from around £1.4 trillion to the current level of £1.61 trillion. This increase has been matched by a similar increase in (nominal) GDP so that the relative stock of debt remains little changed at present at around 76 per cent of GDP.
Chart 3 shows the annual growth rate of net lending (lending net of repayments) by monetary financial institutions to individuals. This essentially captures the growth rate in the stocks of debt, though changes in the actual stock of debt are also be affected by the writing-off of debts. (Click here to download a PowerPoint of the chart.)
We can see quite readily the pick up in lending from 2014. The average annual rate of growth in total net lending since 2014 has been just a little under 3½ per cent. This has been driven by unsecured lending whose growth rate has been close to 8½ per cent per annum, compared to just 2.7 per cent for secured lending. In 2016 the annual growth rate of unsecured lending was just shy of 11 per cent. This helped to fuel concerns about possible future financial distress. These concerns remain despite the annual rate of growth in unsecured debt having eased slightly to 7.5 per cent.
Despite the aggregate debt-to-GDP ratio having been relatively stable of late, the recent growth in debt levels is clearly not without concern. It has to be viewed in the context of two important developments. First, there remains a ‘debt hangover’ from the financial distress experienced by the private sector at the end of the 2000s, which itself contributed to a significant decline in economic activity (real GDP fell by 4 per cent in 2009). This subequently affected the financial well-being of the public sector following its interventions to cushion the economy from the full effects of the economic downturn as well as to help stabilise the financial system. Second, there is considerable uncertainty surrounding the UK’s exit from the European Union.
The financial resilience of all sectors of the economy is therefore of acute concern given the unprecedented uncertainty we are currently facing while, at the same time, we are still feeling the effects of the financial distress from the financial crisis of the late 2000s. It therefore seems timely indeed for individuals to take stock of their stocks of debt.
- UK consumer lending growth slows to new three-year low, mortgage approvals jump
- Shoppers switch to credit card use
- UK households spending more than income for first time in 30 years
- Households spent £900 more than they earned in 2017 marking the first time in THIRTY years the country has had more going out than coming in
- Household debt in UK ‘worse than at any time on record’
- UK households slip into the red for the first time since the Lawson bubble
Reuters, David Milliken and Alistair Smout (29/11/18)
BBC News, Kevin Peachey (28/11/18)
Independent, Ben Chu (26/07/18)
Daily Mail, Tim Sculthorpe (26/07/18)
Guardian, Philip Inman (26/07/18)
Telegraph, Anna Isaac (26/07/18)
- How might we measure the financial distress of individuals?
- If individuals are financially distressed how might this affect their consumption behaviour?
- How might credit constraints affect the relationship between consumption and income?
- What do you understand by the concept of ‘cash flow effects’ that arise from interest rate changes?
- How might the accumulation of secured and unsecured debt have different effects on consumer spending?
- What factors might explain the rate of accumulation of debt by individuals?
- What is meant by ‘financial resilience’ and why might this currently be of particular concern?