Mike Konczal posts a summary of a working paper by Mason and Jayadev. The leader:

Changes in debt-income ratios can be attributed to primary borrowing, interest rates, growth, and inflation. In a new working paper, we apply such a decomposition to the evolution of U.S. household debt.  This shows that changes in borrowing behavior has played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of “Fisher dynamics” — the mechanical result of higher interest rates and lower inflation after 1980. Bringing leverage back down will similarly require contributions from factors other than reduced borrowing

Having read over the post I would say there is both more and less here than meets the eye. I think the authors are essentially correct – declines in inflation are the key driver behind high household indeptedness.

What they are not as explicit about is that indeptedness is fundamentally a nominal phenomenon. Its always difficult for me to lucidly explain this even to myself but these two graphs should help.

First, look at how household debt has grown

FRED Graph

An almost inexorable rise since the early 1980s. Even now we are barely back to 2005 levels.

Now compare that to debt service payments

FRED Graph

Though by 1995 the level of debt-to-income had gone up by about 50%, debt service payments were almost as low as the through in the 1980s.

And, today while debt-to-income is just shy of 200% of early 1980s levels, debt service payment are not that far off the bottom.

This is because inflation causes your debt-to-income ratio to fall faster, but it does this by requiring a higher payment at even given level of debt. So even though debt-to-income was much lower in 1985, for example, debt payments were higher.

One of the things I think these means – but I haven’t worked it out – is that low inflation creates a fundamentally more precarious economy, even without thinking about the zero lower bound.

In short when a lot of your payment is interest then the “price of debt” is less sticky. When lots of your payment is principle then the “price of debt” is very sticky.

The current recession has a weird extra stickiness because the falling price of land now means that lots of folks can’t refinance or sell out.

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