The role of debt in UK household spending decisions Phil Bunn Bank of England Conference on the Causes and Consequences of the Long UK Expansion: 1992 to 2007 19 September 2013 1
Outline • Overview of developments in household balance sheets – Trends in household balance sheets – How have these affected consumption • Research on how debt affects consumption – Should debt affect spending? – Methodology – Econometric results – Implications for aggregate consumption – Causality versus differing expectations
Developments in household balance sheets
Household debt to income Per cent of post-tax annual income 180 Total debt to income Mortgage debt to income 160 140 120 100 80 60 40 1987 1992 1997 2002 2007 2012 • The stock of debt more than trebled between 1992 and 2007 • Mortgage debt accounts for around 80% of total household debt
House prices and mortgage debt relative to income Per cent of post-tax Index (1999 = 100) annual income 140 180 160 House price to income 120 (rhs) 140 100 Mortgage debt 120 to income (lhs) 80 100 60 80 40 60 1987 1991 1995 1999 2003 2007 2011 • Increases in mortgage debt appear largely related to rises in house prices
Real interest rates Per cent 6 Five-year real 4 interest rates, five- years forward 2 0 -2 1987 1992 1997 2002 2007 2012 • Falls in real interest rates are likely to have been a factor behind increases in debt and house prices • Looser credit conditions will also have played a role
Net acquisition of assets and liabilities Per cent of post-tax income 25 Acquisition of 20 financial liabilities Acquisition of 15 financial assets 10 5 Acquisition of deposits 0 -5 1987 1992 1997 2002 2007 2012 • Household acquired financial assets at a similar rate to liabilities
Household assets and liabilities Per cent of annualised post-tax income 500 450 Financial assets 400 350 300 Residential 250 buildings assets 200 150 100 Financial liabilities 50 0 1987 1992 1997 2002 2007 2012 • Balance sheet positions also depend on changes in asset prices
Household capital gearing Per cent 50 Excluding housing assets 45 Including housing assets 40 35 30 25 20 15 10 5 0 1987 1992 1997 2002 2007 2012 • Over the 1992 to 2007 period, debt did not increase substantially in relation to the value of assets
Net wealth Indices (1992 = 100) 450 Nominal net financial wealth Nominal net wealth including housing 400 Real net financial wealth 350 Real net wealth including housing 300 250 200 150 100 50 0 1987 1991 1995 1999 2003 2007 2011 • Net wealth rose significantly over the long expansion
Changes in the distribution of balance sheets by age Debt Gross wealth £, thousands £, thousands 250 80 70 1995 1995 200 2005 2005 60 50 150 40 100 30 20 50 10 0 0 18-24 25-34 35-44 45-54 55-64 65+ 18-24 25-34 35-44 45-54 55-64 65+ • Distribution of balance sheets has changed significantly • Younger households have become more indebted, whilst older households have become wealthier
Annual consumption growth Per cent 12 10 1999-2007 1992-1998 average 8 average 6 4 2 0 -2 1956-2013 average -4 -6 1987 1992 1997 2002 2007 2012 • Consumption grew at a similar rate between 1992 to 1998 (when D/Y was flat) as it did between 1999 and 2007 (when D/Y was rising) • No clear evidence that increases in debt led to a consumption boom
Household saving ratio Recessions (a) Saving ratio (b) Per cent 14 12 10 8 6 4 2 0 -2 1987 1992 1997 2002 2007 2012 • Saving ratio also declined at similar rate when debt to income was rising to when it was flat
Housing equity withdrawal and consumption Per cent of Per cent of disposable income disposable income 10 102 8 100 6 98 4 96 2 94 0 92 -2 90 Consumption (rhs) -4 88 Housing equity withdrawal (lhs) Unsecured lending (lhs) -6 86 1987 1992 1997 2002 2007 2012 • There is some relationship between consumption and housing equity withdrawal
Real house prices and consumption (annual growth) Per cent Per cent 30 15 25 20 10 15 10 5 5 0 0 -5 -10 -5 Consumption (rhs) -15 House prices(a) (lhs) -20 -10 1987 1992 1997 2002 2007 2012 • House prices and consumption are well correlated, but not clear whether this reflects causality
Key points on household balance sheets • Big increases in debt largely reflect higher house prices • Falls in real interest rates and looser credit conditions are likely to have been a factor behind those increases • Household acquired assets at a broadly similar rate to liabilities • There have been significant changes in the distribution of balance sheets • No evidence of a debt fuelled consumption boom, but hard to tell from aggregate data • Increases in wealth are likely to have supported consumption
Research on how debt affects consumption
Saving ratios of different groups of households Outright owners Per cent Renters 30 Low debt mortgagors High debt mortgagors Total LCFS 20 10 0 -10 -20 1992 1995 1998 2001 2004 2007 2010 • High debt mortgagors have typically had the lowest saving ratios, but they have seen the biggest increases since the crisis
Motivation • High debt levels may make households more vulnerable to shocks • Have indebted UK households made larger adjustments to their spending in response to shocks associated with the financial crisis? • Evidence from the US suggests debt has been important, Dynan (2012) and Mian, Rao and Sufi (2013) • Understanding how debt affected consumption before the crisis is also important
Should debt affect household spending? • In a simple life-cycle model, households borrow or save to smooth their consumption • Debt has no effect on spending decisions • But assumptions of the simple model may not hold – Households’ ability to borrow may change – Households are not certain about their lifetime incomes • Debt could affect consumption temporarily, if households ability to bring forward consumption changes • High debt levels may make households respond differently to shocks
Research design • Household level consumption equation including a mortgage debt to income variable • Coefficient on the leverage variable is allowed to vary over time • Life-cycle type model, similar to that used in housing and consumption literature (Attanasio et al (2009)), but including debt variable • Does not prove whether there is a causal relationship between debt and consumption
Research Design We estimate the following equation: ' ' ' ' c β D / Y β D / Y * year β year β cohort β X e it 1 it 2 it 3 t 4 i 5 it it vector i t c log of real non-housing consumption for household, , at time, it ratio of outstanding mortgage debt to household disposable D / Y income year time dummies cohort cohort dummies, captures a pseudo fixed effect Controls X
Data • Living Costs and Food Survey (formerly FES) • Repeated cross section of UK households (household level) • 1992 – 2011 • 5,300 per year • Use non-housing consumption • Secured debt data: level of outstanding mortgage debt
Results • Households with high debt to income ratios tend to consume more • On average, household with a debt to income ratio of 3 rather than 2 have consumed about 2% more • Impact of debt on consumption does vary over time
Regression results Impact of a 1 unit increase in debt to income ratio on consumption, relative to 2007 Significant at 5% level Per cent Debt & year interaction terms ( β 2) 5 4 3 2 1 0 -1 -2 -3 -4 -5 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 • Debt had a larger effect on consumption in the early 2000s and a smaller effect after 2007
Regression results Impact of a 1 unit increase in debt to income ratio on consumption 2007 impact Per cent Impact relative to 2007 Total 6 4 2 0 -2 -4 19921994 199619982000 2002 20042006 2008 2010 • Overall effect of debt on consumption is always positive
Regression results Non-durable Durable Significant at 5% level Significant at 5% level Per cent Per cent Debt and year interactions ( β 2) Debt and year interactions ( β 2) 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 • Durable consumption effect seems to have been stronger pre-crisis • Similar effects on durable and non-durable consumption after the crisis
Impact of debt on aggregate consumption Non-housing consumption Saving ratio Per cent Indices (1992 = 100) 14 National Accounts data 190 12 Excluding the estimated 170 impact of debt 10 8 150 6 130 4 National Accounts data 110 2 Excluding the estimated impact of debt 0 90 1992 1995 1998 2001 2004 2007 2010 1992 1995 1998 2001 2004 2007 2010 • Increases in debt were largely matched by an accumulation of assets, but some evidence that debt supported consumption before the crisis
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