Debt did not spiral upwards due to poor household decisions

Mike Konczal has a good synopsis of a new paper by JW Mason and Arjun Jayadev that suggests:

[T]he conservative theory explaining increased household borrowing in terms of shorter time horizons and a general lack of self-control, and the liberal theory explaining it in terms of efforts by those further down the income ladder to maintain consumption standards in the face of a falling share of income, need some rethinking.

They find that (my bold):

If interest rates, growth and inflation over 1981-2011 had remained at their average levels of the previous 30 years, then the exact same spending decisions by households would have resulted in a debt-to-income ratio in 2010 below that of 1980… the entire growth in debt relative to earlier periods (17 percent of household income, compared with just 3 percent in the 1970s) is due to the slower growth in nominal income as a result of falling inflation. In other words, there is no reason to think that aggregate household borrowing behavior changed after 1980; indeed households rescued their borrowing in the face of higher interest rates just as one would expect rational agents to. The problem is that they didn’t, or couldn’t, reduce borrowing fast enough to make up for the fact.

Good debunking of standard moralistic or simplistic class based analysis that doesn’t really capture what was going on. The fact is the Reagan-Volcker years ended inflation and the Bush years ended wage gains so debt as a percentage of  income (reflected in GDP) rose.

They conclude somewhat somberly for the US:

We draw two main conclusions. First, as a historical matter, you cannot understand the changes in private sector leverage over the 20th century without explicitly accounting for debt dynamics. The tendency to treat changes in debt ratios as necessarily the result in changes in borrowing behavior obscures the most important factors in the evolution of leverage. Second, going forward, it seems unlikely that households can sustain large enough primary deficits to reduce or even stabilize leverage. Even the very large surpluses of 2006-2011 would not have brought down leverage at all in the absence of the upsurge in defaults; and in the absence of large federal deficits and an improving trade balance the outcome would have been even worse since reductions in household expenditure would have reduced aggregate income.  As a practical matter, it seems clear that, just as the rise in leverage was not the result of more borrowing, any reduction in leverage will not come about through less borrowing. To substantially reduce household debt will require some combination of financial repression to hold interest rates below growth rates for an extended period, and larger-scale and more systematic debt write-downs.

Basically the Fed needs to target inflation substantially above the interest rate (which at the present is zero) and debt writedowns, i.e. default and banking troubles, are likely to continue for a while as well.

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