Is Record-High Consumer Debt a Good or Bad Thing?

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The Federal Reserve issued its report on consumer credit Monday afternoon, and the news is that consumer credit rose in November 2017 at a seasonally adjusted annual rate of 8.8%. Total outstanding debt reached $3.83 trillion, an increase of $27.9 billion month over month.

That 8.8% increase is the largest in two years, and the monthly increase is the largest in 16 years. Is this a good thing or is it a bad thing?

Over the past five years, consumer debt (all household debt excluding mortgages and home equity loans) has risen at about twice the rate of household income, primarily the result of auto loans and student borrowing, according to a report by Ray Boshara from the Center for Household Financial Stability, a project of the Federal Reserve Bank of St. Louis.

The Center suggests that rising household debt levels could indicate that several things are happening:

  • More Americans are optimistic about the economy.
  • More Americans are investing in assets that build wealth, like homes and higher education.
  • Americans who have paid off their old loans are taking out new loans.
  • More Americans are feeling financial stress and are using debt to purchase necessities.

Higher levels of household debt can boost consumption and GDP growth in the short term (one or two years), but suppress them in the longer term according to Boshara. How and if household debt affects economic growth depends on three things: does the debt improve labor productivity or boost local demand for goods and services; the concurrent extent of leverage in the banking system; and the stability of the assets purchased with the debt. (One assumes that cryptocurrencies are not necessarily stable assets.)

Boshara also points out that high levels of household debt do not necessarily pose a systemic risk to the economy but that “rising debt can be a drag on economic growth even if not a systemic risk, and longer-term reliance on debt to sustain consumption remains highly concerning as well.”

And what should politicians do about rising household debt? First, they need to put it on their radar screens and watch for signs that could further weigh on indebted households and slow economic growth. These signs include low productivity growth, higher interest rates, new financial and banking regulation and rising costs for higher education.

Boshara concludes:

Indeed, levels of household debt have often served as a reflection of larger, structural, technological, demographic and policy forces that help or harm consumers. It only makes sense, then, that policy and institutional measures must be considered to ameliorate debt levels and their impact on families and the economy.

After all, what’s good for families is good for the economy, and vice versa.

More details and background are available at the St. Louis Fed’s website.