MPs are concerned by rising household debt. John McDonnell, the shadow chancellor, says his party is “deeply worried” about it, and some MPs want a public inquiry into it.
These worries aren’t wholly wrong. A recent paper by Atif Mian, Amir Sufi and Emil Verner shows that rises in the ratio of household debt to GDP ratio lead to lower GDP growth.
This, though, isn’t a pressing concern in the UK now. Total household debt has grown by only 4 per cent in the last 12 months, which is only very slightly more than the 3.6 per cent rise in GDP. And it’s far less than the double-digit growth we saw in the years before the financial crisis.
Such modest growth reflects the fact that the vast majority of household debt (£1.35 trillion of the £1.55 trillion total) is mortgage debt which rose by only 3.1 per cent in the last year. What is increasing is non-mortgage debt, which rose 9.8 per cent in the year to July.
Whether we should worry about this depends upon three questions.
First, who’s borrowing? It’s perfectly rational for many people to borrow: youngsters who can look forward to rising wages; people going through temporary unemployment who’ll get a good job soon; or those who can take advantage of offers of zero per cent finance. If these are borrowing, there’s little problem. If, on the other hand, borrowers are irrationally optimistic and won’t be able to repay, then there is. Aggregate data, however, tell us nothing about this.
Secondly, for whom is debt a problem? Take the car market, about which the Bank of England is worried. One danger here is that customers who bought cars on personal contract plans might hand back the car at the end of the deal rather than make the final payment to buy it outright. This would leave dealers with a surfeit of cheap cars. That means trouble for them, and for car finance companies – and in fact stocks such as Pendragon and Paragon have done badly partly because of this fear. But it’s not a problem for customers.
In this sense, the problem isn’t debt but lending. Much the same was true in the financial crisis. Northern Rock and Bradford & Bingley didn’t fail because households defaulted on their loans. They did so because the freezing of interbank markets meant they couldn’t refinance what were decent loan books.
A third question is: will debt cause a downturn or merely amplify it?
It might cause a downturn for wholly rational reasons. For example, car sales are now falling not because customers are burdened with excessive debt but simply because so many people bought cars in 2015 and 2016 that they don’t need new ones now. On the other hand, debt might cause a downturn if overoptimistic households realise they are over-geared and cut spending.
Alternatively, even if debt is sustainable in normal times, it might exacerbate a recession. If, for example, unemployment rises for other reasons people with high debt will cut their spending more than they would if they were cash-rich. In this way, debt might exacerbate a downturn but not cause it.
The truth is that nobody really knows how big an economic problem household debt is: it depends upon the distribution of that debt and of future shocks to households’ finances, neither of which are known.
Herein, though, lies something that annoys me. Underlying the idea that household debt is a big worry is an ideological assumption – that ordinary people are irrational and mismanage their affairs. What this overlooks is that recessions in the past have been due not to errors made by consumers but by policy-makers and company managers: excessive tightness of monetary or fiscal policy, reckless lending or excessive capital spending and so on. (It is not impossible that the handling of the Brexit negotiations will prove another such mistake.) Fretting about household debt distracts us from the fact that bigger threats to our prosperity come from those in power.
