Skip to content

Will Consumer Debt Grow?

Share this Story on Facebook, X, Text, LinkedIn, Gmail, Yahoo Mail, or Outlook

Over the past year, I’ve been getting a lot of questions after presentations about consumers and whether they will continue to take on debt.  Consumers fuel about sixty percent of gross domestic product so they are an important driver of the economy.  However, we’ve been through such a bad recession that consumer debt is declining.  Is it a permanent shift?

The Federal Reserve Board produces a quarterly debt service ratio that estimates required debt payments on outstanding mortgage and consumer debt relative to disposable personal income. It hit a high of 13.96% in the third quarter of 2007—just before the recession began.  The latest data for the third quarter of 2010 shows debt service dropped to 11.89%, the lowest rate since the first quarter of 1999.

Although consumer debt typically declines during recessions, it has contracted at a faster pace during the past recession. Some of the reduction in debt is likely due to the high unemployment rate and reluctance of consumers to take on debt.

Some of the reduction in debt is inflicted by banks that have tightened lending standards such as requiring larger down payments on mortgages or higher credit scores to obtain credit cards.  The October 2010 survey of senior loan officers indicates that changes in standards and terms on household loans were mixed. Some banks loosened standards on installment loans while others reported reducing the size of credit lines on existing credit card accounts.

As the unemployment rate comes down after the recession, consumers typically start to take on more debt and banks loosen up their lending standards.  I would expect to see the same as the economic expansion gains ground.  Although the last recession was severe and an unemployment rate that remains near 10% is impacting current credit usage, it is not as bad as the Great Depression that elicited long-lasting changes in consumption when the unemployment rate was greater than 20% throughtout four straight years.

An article in the October 2010 issue of Business Economics written by professors Diane Schooley and Debra Drecnik Worden found that 15% of the respondents to the 2007 Federal Reserve Board Survey of Consumer Finances said it was okay to borrow to pay for luxury items while 50% said it was okay to borrow to cover living expenses. They also found that borrowing was significantly more acceptable for younger households.

Based on early results from consumer spending during the Christmas holidays, it appears that attitudes about debt have not permanently changed.  The Federal Reserve will be giving us a better answer early in 2012 when they expect to release the summary results of the 2010 Survey of Consumer Finances.

Republished with permission from the Richmond Times-Dispatch.

Share this Story on Facebook, X, Text, LinkedIn, Gmail, Yahoo Mail, or Outlook

Join Our Email List

Sign me up for:
This field is for validation purposes and should be left unchanged.