UK household debt is high relative to income. But is it “unsustainable”? Some commentators say “it is”; others say “there is no reason to worry”. To investigate, we build a simple model of the economic relationships between household debt, house prices and real interest rates which we believe must hold in the long run. In our model there is no single threshold beyond which debt suddenly becomes unsustainable, but we argue that household debt should be broadly sustainable under any rise in real interest rates of up to about 2 percentage points (pp) from current levels. We also show that falling real interest rates may have contributed around 20-25pp to the rise in the household debt-to-GDP ratio since the 1980s.
Stephen Burgess, Oliver Burrows, Antoine Godin, Stephen Kinsella and Stephen Millard.
How can large open economies deal with persistent imbalances now and into the future? This question became particularly pertinent in the Great Moderation where, despite stability in output and inflation, sectoral financial balances, both within and across countries, widened. In a recent Staff Working Paper, we developed a model of the UK economy to assess how economic and financial imbalances are likely to evolve over longer periods. Here, we show how we can use this model to examine the evolution of financial balances under different scenarios. We think models like this can form a useful addition to the suite of models called upon by policy-makers to help in their decision making.
Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England or its policy committees.