Private and public debt Flashcards
What is meant by the “Private debt boom” in the US today?
There is a narrative about a debt monster that has taken over the US from after WW2 and until today.
Why?
- Huge increases in household debt
- Both housing and non-housing debt has increased
What are the different views on why debt is increasing in the US today?
View 1: Common view out there: Rising debt is linked to rising inequality
- People are borrowing to stay in the middle class/keep their standard of living even though they are doing worse financially.
- Borrowing is the only way to get by for poor people
View 2: The professors view (Econ view): People only borrow when they have optimistic expectations about the future
- It would not be rational to borrow when things are going badly.
How is the American debt distributed across the different income groups?
Middle class are responsible for most of the debt throughout the period
Both the bottom 50% and the 50-90% have experienced huge increase in debt to income ratios → debt is growing relative to income (which we know is pretty much stagnated for these groups)
How can the middle class be responsible for most of the debt, when they have experienced no income growth?
It seems contraintuitive that this group (middle class) is responsible for so much of the borrowing in a period where they have not experienced any income growth –> they should not be optimistic about the future, so why are they borrowing?
Answer: Their assets have grown in value –> they are getting wealthier
How can house prices explain the big middle class debt?
Which assets do middle class people typically have? → houses
So when the house market is going well (as it was in this period), then the middle class becomes wealthier (because their assets appreciated in value) even though they did not experience income increases.
The important driver of debt accumulation in the US
→ Middle class people taking up more housing debt against the increasing prices of the houses to finance other stuff (consumption, cruises, plasma TV etc.)
How can debt accumulate? (hint: extensive vs intensive)
Two ways in which debt can accumulate: Extensive vs. intensive margin
Extensive:
- More people take on debt (number of debtors increasing)
Intensive:
Conditional on having debt already, you take up more debt (you take on bigger debt relative to your income).
Which margin has been dominant in the empirics?
- The biggest boom in debt occurred between 1983 and 2007
- This was mainly due to intensive margin of housing debt
- People who have housing debt take up more housing debt relative to their value (extract equity)
Is it rational for middle class people to take up more housing debt? (extract mortgage equity)
Yes → because when your lifetime wealth increases, it is rational to equalize your consumption over the years (to keep the same standard of living). So if you don’t have the money right now, it can be rational to borrow.
What are the risk of middle class people extracting mortgage equity?
What happens when the middle class finance their living through equity extractions from their house mortgages?
- Their balance sheets becomes very sensible to house market changes
- Their income to debt ratio is high → so if you have a shock to both your income and the housing market, the consequences will be big.
Overall: Rising fragility
How has public debt developed over time?
Since 1970s the public debt ratio (debt in percent of GDP) has increased substantially until today in developed countries
What arguments are used to explain the rise in public debt?
One view (conservative view):
- The big welfare state and demographic change has increased public expenditures and the willingness to tax people has not increased, so governments have borrowed to pay for it → increase in public debt
Another view:
- GDP growth has slowed down substantially → smaller tax base → less money to pay the debt.
