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.

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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.
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