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
An almost inexorable rise since the early 1980s. Even now we are barely back to 2005 levels.
Now compare that to debt service payments
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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Saturday ~ February 25th, 2012 at 6:05 am
Curt Doolittle
You’re right. You’ve been right all along.
But you aren’t addressing the political problem. You’re treating this episode like Krugman does, as if there is a widespread failure to understand that cheap credit is available for stimulus which would move the entire economy. When the problem is the KIND OF STIMULUS and the general distrust of government by all parties to apply a STIMULUS justly. People will suffer significantly to prevent political externalities.
How can stimulus be applied so that it does not violate political sensibilities? Unless you provide that answer you are a methodological egoist and litte else.
Conservatives will tolerate investment that produces material returns and not purely financial returns, and that does not empower the state.
I’ve teased you before that the only reason you don’t go there is because you can’t. That doesn’t mean you shouldn’t.
Saturday ~ February 25th, 2012 at 12:31 pm
JW Mason
Very interesting response, will take some digestion. You are certainly right that higher inflation means that higher debt service payments as a fraction of income are compatible with stable debt-to-income ratios. The sense in which this makes the price of debt “more sticky” I’m struggling with. Do you just mean that when a higher fraction of payments are interest, changes in interest rates have a larger effect on debt-service ratios?
The other thing it’s important to realize is that about 10 percent of household debt has been written off over the past four years. So that accounts for pretty much the entire fall in your blue line, and half the fall in your red one. (Pre-2007, annual write-offs ere on the order of half a percent.)
Saturday ~ February 25th, 2012 at 3:16 pm
Jon
Karl, I’m not following your claim that the low-inflation regime is less stable/more sticky. More explanation, please. Perhaps start by clarifying the role of adjustable-rate versus fixed-rate debt in your claim, if there is one.
Saturday ~ February 25th, 2012 at 3:38 pm
Paul
My understanding of Karl’s argument goes like this.
A higher proportion of debt payments are comprised of interest in a higher inflation regime. When the economy enters a recession, interest rates fall, and people who are able to refinance their debts also see their debt payments fall due to lower interest payments. This softens the impact of recessions.
In a low inflation regime, principal repayments make up a higher share of debt payments. Debtors do not get much relief from falling interest rates during recessions as most of their debt payments are principal repayments. Hence, in a low inflation regime interest rate changes are a much less potent counter-cyclical force.
Saturday ~ February 25th, 2012 at 3:48 pm
JW Mason
Ok, that’s what I thought. Thanks!
Saturday ~ February 25th, 2012 at 4:57 pm
RickR
Also, in a higher inflation regime, the real value of the principle is shrinking, so it becomes somewhat easier to pay off the principle as the loan ages. Even if the inflation is expected and is factored into the interest rate, in a higher inflation regime a greater proportion of the real value of the loan is paid earlier in the life of the loan, and in a lower one the real return of the loan is spread out more in time. So as the loan ages, it is easier (in real dollars) to pay it off than a loan of similar age in the lower inflation regime.
Sunday ~ February 26th, 2012 at 12:31 pm
Jon
Paul, a new fixed-rate loan will usually not be on better terms than the old one if the term of the loan is long.
Thing brings me right back to my question about adjustable-rate vs. fixed-rate debt.
One of the meme’s of the crisis was that ARMs were an evil creation that should be banned. In as much as Karl has a point here, his point is surely the other way around, ARMs are stabilizing when inflation is high. (What people often forget about an ARM is that they are self-insuring against interest-rate fluctuations. ARMs have lower rates ceteris paribus, and you should be investing that differential in a safe asset like an insurer would… but I digress.)
Suppose you’re not in favor of the risk dynamics of ARMs. We need only look to Canada where the interest-rate is fixed for only 5-10 years. Now your refinancing claim could work.