The spectre of debt has awoken many of us in the night. Indebtedness is a key economic issue in the 2010s. Economists are devoting ever increasing amounts of research time trying to understand its impact on economic behaviour. This will not surprise you when you learn that the debt owed by the UK non-bank private sector to banks stood at £2.17 trillion at the end of September. This is the equivalent to 150% of annual GDP.
Chart 1 shows the stock of outstanding lending by Monetary Financial Institutions (banks and building societies) to the non-bank private sector bank since 1979. Back then the non-bank private sector had bank debt to the tune of around £70 billion or 10 per cent of GDP. Today’s figure is nearly 3000 per cent higher! Of this debt, around about 55 per cent is currently held by the household sector, 27 per cent by Other Financial Corporations (such as insurance companies and pension funds) and 18 per cent by private non-financial corporations. (Click here for a PowerPoint of the chart.)
Chart 2 shows the stocks of debt as percentages of annual GDP. We can infer from it that there are waves of growth in bank debt. Two notable periods are during the 1980s and again from the late 1990s up to the financial crisis of the late 2000s. During the early and mid 1990s the relative size of debt stocks tended to stabilise while in the early 2010s the actual stocks of debt, as well as relative to GDP, declined. A credit binge seems to be followed by a period of consolidation. (Click here for a PowerPoint of the chart.)
It is important that we understand the drivers of the growth of debt. The impact of debt on the balance sheets of the non-bank private sector and on banks themselves has implications for economic behaviour. In the early 2010s this has been to markedly slow the pace of growth through its impact on aggregate demand. Economic agents have, in general, looked to consolidate. There is no doubt that this partly reflects a precautionary motive. An important means by which debt and the balance sheets on which it is recorded affect behaviour is through a precautionary mechanism. This is difficult to accurately quantify because it represents a psychological influence on spending. Furthermore, it is affected by the prevailing circumstances of the time.
In looking to understand the factors that affect the growth of debt we may, as a result, learn more about the framework within which we may want banks and their customers to operate. Consequently, we may be in a better position to ensure sustainable longer-term growth and development. If there are cycles in credit it is important that we understand why they arise and whether, as some have suggested, they are an inherent part of the financialised economy in which we live. If they are, can we mitigate their potentially destabilising effects?
Articles
Retail shares facing nightmare before Christmas The Telegraph, John Ficenec (9/11/14)
Growing wealth inequality in the UK is a ticking timebomb The Guardian, Danny Dorling (15/10/14)
Richest 10% of Britons now control more than half the country’s wealth: Nation is only member of G7 where inequality between rich and poor has increased this century Mail Online, Mark Duell and Corey Charlton, (15/11/14)
Household debt is growing as families struggle Yorkshire Evening Post (31/10/14)
Consumer spending forecast to be the highest for four years The Telegraph, Ashley Armstrong (10/11/14)
Data
Statistical Interactive Database Bank of England
Quarterly National Accounts, Q2 2014 Dataset Office for National Statistics
Questions
- What is the non-bank private sector?
- What factors might affect the rate at which non-bank private sector debt stocks grow?
- How might we go about assessing whether the aggregate level of lending by financial institutions to the non-bank private sector is sustainable?
- How might we go about assessing whether the level of lending by individual financial institutions to the non-bank private sector is sustainable?
- What information is conveyed in the balance sheets of economic agents, such as households and private non-financial corporations
- What is meant by precautionary saving?
- Can precautionary saving occur when the economy is growing strongly?
- What are the mechanisms by which non-bank private sector debt could impact on economic behaviour?
As the old year gives way to the new, papers have been full of economic forecasts for the coming year. This year is no exception. The authors of the articles below give their predictions of what is to come for the global economy and, for the most part, their forecasts are relatively optimistic – but not entirely so. Despite a sunny outlook, there are various dark clouds on the horizon.
Most forecasters predict a higher rate of global economic growth in 2014 than in 2013 – and higher still in 2015. The IMF, in its October forecasts, predicted global growth of 3.6% in 2014 (up from 2.9% in 2013) and 4.0% in 2015.
Some countries will do much better than others, however. The USA, the UK, Germany and certain developing countries are forecast to grow more strongly. The eurozone as a whole, however, is likely to see little in the way of growth, as countries such as Greece, Spain, Portugal and Italy continue with austerity policies in an attempt to reduce their debt. 
Chinese growth has slowed, as the government seeks to rebalance the economy away from exports and investment in manufacturing towards consumption, and services in particular. It is still forecast to be 7.3% in 2014, however – well above the global average. Japanese growth has picked up in response to the three arrows of fiscal, monetary and supply-side policy. But this could well fade somewhat as the stimulus slows. The table shows IMF growth forecasts for selected countries and groups of countries to 2018.
Much will depend on what happens to monetary policy around the world. How quickly will monetary stimulus taper in the USA and in Japan? Will the ECB introduce more aggressively expansionary monetary policy? When will the Bank of England start raising interest rates?
Growth within countries is generally favouring those on higher incomes, with the gap between rich and poor set to continue widening over the coming years. The pay of top earners has continued to rise considerably faster than prices, while increasingly flexible labour markets and squeezed welfare budgets have seen a fall in living standards of many on low incomes. According to a Which? survey (reported in the Independent article below), in the UK:
Only three in ten expect their family’s situation to improve in the new year, while 60% said they are already dreading the arrival of their winter energy bill. The Which? survey also found that 13 million people could afford to pay for Christmas only by borrowing, with more than four in ten using credit cards, loans or overdrafts to fund their festive spending. A third of people (34%) also dipped into their savings, taking an average of £450 from their accounts.
If recovery is based on borrowing, with real incomes falling, or rising only very slowly, household debt levels are likely to increase. This has been stoked in the UK by the ‘Help to Buy‘ scheme, which has encouraged people to take on more debt and has fuelled the current house price boom. This could prove damaging in the long term, as any decline in confidence could lead to a fall in consumer expenditure once more as people seek to reduce their debts.
And what of the global banking system? Is it now sufficiently robust to weather a new crisis. Is borrowing growing too rapidly? Is bank lending becoming more reckless again? Are banks still too big to fail? Is China’s banking system sufficiently robust? These are questions considered in the articles below and, in particular, in the New York Times article by Gordon Brown, the former Prime Minister and Chancellor of the Exchequer.
Articles
Global economy: hopes and fears for 2014The Observer, Heather Stewart and Larry Elliott (29/12/13)
Looking ahead to 2014 BBC News, Linda Yueh (20/12/13)
Low hopes for a happy new financial year in 2014 Independent, Paul Gallagher (29/12/13)
Brisk UK economic growth seen in 2014 fuelled by spending – Reuters poll Reuters, Andy Bruce (12/12/13)
GLobal Economy: 2014 promises faster growth, but no leap forward Reuters, Andy Bruce (29/12/13)
My 2014 Economic Briefing Huffington Post, Tony Dolphin (27/12/13)
Three UK Economy Stories that will Dominate in 2014 International Business Times, Shane Croucher (27/12/13)
Who You Calling a BRIC? Bloomberg, Jim O’Neill (12/11/13)
Hope and Hurdles in 2014 Project Syndicate, Pingfan Hong (27/12/13)
On top of the world again The Economist (18/11/13)
Digging deeper The Economist (31/10/13)
BCC Economic Forecast: growth is gathering momentum, but recovery is not secure British Chambers of Commerce (12/13)
Eight predictions for 2014 Market Watch, David Marsh (30/12/13)
Stumbling Toward the Next Crash New York Times, Gordon Brown (18/12/13)
Central banks must show leadership to rejuvenate global economy The Guardian, Larry Elliott (1/1/14)
Global economy set to grow faster in 2014, with less risk of sudden shocks The Guardian, Nouriel Roubini (31/12/13)
A dismal new year for the global economy The Guardian, Joseph Stiglitz (8/1/14)
Forecasts and reports
World Economic Outlook (WEO) IMF (October 2013)
Economic Outlook OECD (November 2013)
Output, prices and jobs The Economist
Bank of England Inflation Report: Overview Bank of England (November 2013)
Questions
- What reasons are there to be cheerful about the global economic prospects for 2014 and 2015?
- Who will gain the most from economic growth in the UK and why?
- Why is the eurozone likely to grow so slowly, if at all?
- Are we stumbling towards another banking crisis, and if so, which can be done about it?
- Why has unemployment fallen in the UK despite falling living standards for most people?
- What is meant by ‘hysteresis’ in the context of unemployment? Is there a problem of hysteresis at the current time and, if so, what can be done about it?
- Explain whether the MINT economies are likely to be a major source of global economic growth in the coming year?
- Why is it so difficult to forecast the rate of economic growth over the next 12 months, let alone over a longer time period?
As of 31 October 2013, British households had a stock of debt close to £1.43 trillion. Economists are increasingly recognising that the financial well-being of economic agents is an important macroeconomic issue. The financial position of households, businesses and governments can be expected to affect behaviour and, hence, economic activity.
We can calculate the net financial wealth of households as the difference between their stock of financial assets (savings) and their financial liabilities (debt). The latest figures from the Bank of England’s Money and Credit show that as of Halloween 2013, British households had amassed a stock of debt of £1.4296 trillion. It is certainly a large figure since it not far short of the expected GDP figure for 2013 of around £1.6 trillion.
The chart above helps to show that of the aggregate household debt, £1.271 trillion is secured debt (debt secured against property). The remaining stock of £158.589 billion is unsecured debt (e.g. overdrafts, outstanding credit card debt and personal loans). In short, 89 per cent of the stock of outstanding household debt is mortgage debt. (Click here to download a PowerPoint of the chart.)
In January 1994 the stock of secured debt stood at £358.75 billion and the stock of unsecured debt at £53.773 billion. 87 per cent of debt then was secured debt and, hence, little different to today. The total stock of debt has grown by 247 per cent between January 1994 and October 2013. Unsecured debt has grown by 199 per cent while secured debt has grown by 254 per cent.
But, consider now the path of debt between the end of October 2008 and October 2013. During this period, the monthly series of the stock of unsecured debt has fallen on 52 occasions and risen on only 9 occasions. In contrast, the stock of secured debt has fallen on only 10 occasions and often by very small amounts. Consequently, the stock of unsecured debt has fallen by 22.8 per cent between the end of October 2008 and October 2013. In contrast, the stock of secured debt has risen by 3.9 per cent. The total stock of debt has risen by 0.1 per cent over this period and, therefore, it is essentially unchanged.
The amount of debt accumulated by households is example of the increasing importance of the financial system in our everyday lives. The term financialisation helps to capture this. Financialisation means that economists need to think much more about how financial institutions and the financial well-being of people, businesses and governments affect economic activity. There is little doubt that the financial position or financial health of economic agents, such as households, affects their behaviour. We would expect in the case of households for their financial well-being to exert an influence on their propensities to spending or save. But, just how is an area in need of much, much more research.
Articles
UK household debt hits record high BBC News (29/11/13)
Average household debt ‘doubled in last decade’ Telegraph, Edward Malnick (20/11/13)
£1,430,000,000,000 (that’s £1.43 trillion): Britain’s personal debt timebomb Independent, Andrew Grice (20/11/13)
Data
Money and Credit – October 2013 Bank of England
Statistical Interactive Database Bank of England
Questions
- Outline the ways in which the financial system could impact on the spending behaviour of households.
- Why might the current level of income not always be the main determinant of a household’s spending?
- How might uncertainty affect spending and saving by households?
- Explain what you understand by net lending to individuals. How does net lending to individuals affect stocks of debt?
- Outline the main patterns seen in the stock of household debt over the past decade and discuss what you consider to be the principal reasons for these patterns.
- What factors might explain the rather different pattern seen in the growth of debt since October 2008 compared with that in earlier part of the 2000s?
- What do you understand by the term financialisation? Of what importance is this phenomenon to economic behaviour?
Household debt in the UK has reached a record level. Individuals now owe £1430 billion. This compares with the UK’s general government debt of £1443 billion – also at a record level. These figures are illustrated in the chart (click here for a PowerPoint).
But these figures are nominal. If you look at the real figures (i.e. corrected for inflation), household debt has been falling. In today’s prices, household debt peaked at £1668 billion in March 2008. Also, if you look at household debt as a proportion of GDP, it fell from a peak of 100.96% in May 2009 to 87.43% in July 2013 (see chart). However, since then it has begun rising again, standing at 87.65% in October 2013.
So has household debt become less of a problem? In aggregate terms, the answer is probably yes. However, it is too early to know whether a continuing recovery in the economy will be fuelled by real debt rising again and whether the recovery will encourage people to take on higher levels of debt?
For many people, however, debt has become more and more of a problem. In other words, the aggregate figures conceal what has happened in terms of the distribution of debt. According to a Centre for Social Justice (CSJ) study:
Indebted households in the poorest 10 per cent of the country have average debts more than four times their annual income. Average debt repayments within this group amounted to nearly half their gross monthly income.
And the poorest families, often with very poor credit ratings, are frequently forced to turn to payday lenders, charging sky-high interest rates (see Capping interest rates on payday loans: a government U-turn?).
As mainstream banks reduced access to credit following the financial crash, the market for short-term high-cost credit (payday lenders, pawnbrokers, rent-to-buy and doorstop lenders) increased dramatically and is now worth £4.8 billion a year.
Payday lenders have increased business from £900 million in 2008/09 to just over £2 billion (or around 8 million loans) in 2011/12. Around half of payday loan customers reported taking out the money because it was the only form of credit they could get. The number of people going to loan sharks is also said to have increased – the most recent estimate puts it at 310,000 people.
With rising energy and food bills hitting the poorest hardest, this section of the population could find debt levels continuing to rise, especially if interest rates rise. As Chris Pond, who chaired the CJS study, stated:
The costs to those affected, in stress and mental disorders, relationship breakdown and hardship is immense. But so too is the cost to the nation, measured in lost employment and productivity and in an increased burden on public services.
Articles
£1,430,000,000,000 (that’s £1.43 trillion): Britain’s personal debt timebomb Independent, Andrew Grice (20/11/13)
Average household debt ‘doubled in last decade’ The Telegraph, Edward Malnick (20/11/13)
UK household debt hits record high BBC News (29/11/13)
UK debt crisis: poorest face ‘perfect storm’ Channel 4 News (20/11/13)
One in five struggle with serious debt The Telegraph, Nicole Blackmore (27/11/13)
It doesn’t matter what we do with Wonga: personal debt is about to rocket The Telegraph, Tim Wigmore (26/11/13)
Poorest families ‘need more help over debt’ BBC News (20/11/13)
Report
More than 5,000 people a year ‘homeless’ as household debt crisis deepens, CSJ warns Centre for Social Justice Press Release (20/11/13)
Data
Monthly amounts outstanding of total (excluding the Student Loans Company) sterling net lending to individuals and housing associations (in sterling millions) seasonally adjusted Bank of England
Public Sector Finances First Release – Public Sector Consolidated Gross Debt ONS
Household debt (Economics Indicators update) House of Commons Library (29/11/13)
Questions
- What are the macroeconomic implications of rising levels of household debt?
- Why may an economy which has high levels of household debt be more subject to cyclical fluctuations in real GDP?
- What are the problems of having a recovery driven largely by increased consumer expenditure?
- Why have many people in the poorest sectors of society found their debt levels rising the fastest?
- Why may rising levels of debt of the most vulnerable people make it harder for the Bank of England to use conventional monetary policy if recovery becomes established?
- What policies could be pursued to try to reduce the debts of the poorest people?
- Discuss the effectiveness of these various policies.
There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’!
One of the main underlying problems of the 2008 financial crisis was that household debt had been increasing to unsustainable levels, egged on by banks only too willing to lend, whether as personal loans, on credit cards or through mortgages. When the recession hit, many people sought to reduce their debts by cutting back on spending. This further fuelled the recession.
What the government and most economists hoped was that there would be some rebalancing of the economy, with less reliance on consumer spending to drive economic growth. Instead it was hoped that growth would be driven by a rise in investment and exports. Indeed, the 25% depreciation of sterling exchange between 2007 and 2009 was seen as a major advantage as this would boost the demand for exports and encourage firms to invest in the export sector.
But things haven’t turned out the way people hoped. The recession (or lack of growth) has been much deeper and more prolonged than previous downturns in the economy. Today, real GDP per head is more than 7% below the level in 2007 and many people have seen much bigger declines in their living standards.
But also, despite the austerity policies, the economy has not been ‘rebalanced’ towards exports and investment. Exports are 3% lower than in 2006 (although they did grow between 2009 Q2 and 2011 Q1, but have since stagnated). And investment is 27% lower than in 2006. Household consumption, however, has grown by about 2% and general government consumption by around 9% since 2006. The chart shows the figures, based on 2006 Q1 = 100.
(Click here for a PowerPoint of the chart.)
And recent evidence is that consumption is beginning to grow faster – not because of rising household incomes, but because of falling saving rates. In 2008, the household saving ratio had fallen to nearly 0% (i.e. households were on average saving about the same as they were borrowing). Then the saving ratio rose dramatically as people reined in their spending. Between 2009 and 2012, the ratio hovered around 7%. But in the first quarter of 2013, it had fallen to 4.2%
So the good news is that aggregate demand is rising, boosting economic growth. But the bad news is that, at least for the time being, this growth is being driven by a rise in household borrowing and a fall in household saving. The videos and articles consider whether this is, however, still good news on balance.
Webcasts
Britain’s imbalanced economy The Economist, Zanny Minton Beddoes and Richard Davies (4/7/13)
Britain’s Export Drought: an enduring disappointment The Economist, Andrew Palmer and Richard Davies (9/2/13)
‘Green shoots’ of economic recovery in Rugby BBC News, Paul Mason (12/6/13)
Articles
Is the UK economy seeing the ‘wrong kind’ of green shoots? BBC News, Stephanie Flanders (3/7/13)
The export drought: Better out than in The Economist (9/2/13)
Exports and the economy: Made in Britain The Economist (21/1/12)
The economy: On a wing and a credit card The Economist (6/7/13)
Unbalanced and unsustainable – this is the wrong kind of growth The Telegraph, Jeremy Warner (8/7/13)
The UK economy’s looking up – but no one’s told manufacturers The Guardian, Heather Stewart (10/7/13)
Data
Quarterly National Accounts, Q1 2013 (27/6/13)
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury (June 2013)
ISM Manufacturing Report on Business® PMI History Institute for Supply Management
Questions
- What are forecasters expecting to happen to economic growth in the coming months? Why?
- What factors determine investment? Why has it fallen so substantially in the UK?
- Explain what is meant by the ‘accelerator’. Is the rise in consumption likely to lead to an accelerator effect and, if so, what will determine the size of this effect?
- Why have exports not grown more rapidly despite the depreciation of sterling after 2007?
- What will determine the rate of potential economic growth in the UK economy? How will a rise in real GDP driven by a rise in consumption impact on potential GDP and potential economic growth?
- What supply-side policies would you recommend, and why, in order to increase potential economic growth?
The spectre of debt has awoken many of us in the night. Indebtedness is a key economic issue in the 2010s. Economists are devoting ever increasing amounts of research time trying to understand its impact on economic behaviour. This will not surprise you when you learn that the debt owed by the UK non-bank private sector to banks stood at £2.17 trillion at the end of September. This is the equivalent to 150% of annual GDP. 
