The debt trigger: how household debt can amplify the effect of rising rates

Tuli Saha and Alexandra Varadi

High levels of household indebtedness can amplify negative economic shocks, if highly indebted mortgagors make larger cuts to spending in response to them or are more vulnerable to defaulting on mortgage payments adding to bank losses. These are tail risks which can pose significant financial instability. In this post, we present quantitative evidence on these risks using a local projection model. We find that when the share of highly indebted households increases, aggregate consumption drops more sharply and mortgage arrears increase more in response to interest rate shocks. Our work highlights the importance of managing risky lending through macro and microprudential policy. And it highlights how debt burdens can interact with the monetary transmission mechanism.

Continue reading →

Household debt and labour supply – a new labour market channel

Philip Bunn, Jagjit Chadha, Thomas Lazarowicz, Stephen Millard and Emma Rockall

Does higher household debt lead to greater labour supply? Ahead of the Global Financial Crisis (GFC), UK household debt rose considerably. Since that crisis, the UK labour market has experienced high employment and high participation, alongside relatively weak wage growth. Might these observations be evidence that higher debt leads to higher labour supply? In a recent Working Paper, we attempt to answer this question. We do find a significant channel by which households with higher debt increase their labour supply in response to negative income shocks by more than households with lower (or no) debt. But, we do not think the effect is strong enough to explain the post-crisis strength in employment and participation at the aggregate level.

Continue reading →

Household debt and consumption revisited

Philip Bunn and May Rostom

The academic literature finds that the build-up of household debt before the 2008 financial crisis is linked to weaker consumption afterwards. But there is wider debate over the mechanisms at play. One strand of literature emphasises debt overhang acting through the level of leverage. Others find it was over-optimism acting through leverage growth. In this post, we revisit our previous analysis on leverage and consumption in the UK using synthetic cohort analysis. The correlation between leverage measures and their link to other macroeconomic variables mean it’s challenging to tease out their effects. Yet we find that whilst both mechanisms played a role, there is evidence that debt overhang linked to a tighter credit constraints was the bigger driver.

Continue reading →

The danger zone – when should we worry about how much households spend on their mortgages?

Philip Bunn.

As households spend more of their income making payments on loans they are more likely to get into arrears. This risk rises gradually at first, but above a certain point they enter a danger zone where the probability of arrears rises sharply. Knowing where this danger zone lies is really important because, if it comes a little earlier or a little later, that can make a big difference to the number of people who fall into it, although as this post shows, it is hard to identify this danger zone precisely. Nevertheless, understanding what leads households to get into financial difficulty is crucial for assessing how such difficulties might increase following rises in interest rates or unexpected falls in income.
Continue reading “The danger zone – when should we worry about how much households spend on their mortgages?” →