Rising Household Debt: What It Means for Growth and Stability

IMF Blog, October 3, 2017

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Household debt (including mortgage debt) has been rising since the global financial crisis.
Since 2008, household debt as a proportion of gross domestic product has grown significantly in a sample of 80 countries.
- Among advanced economies, the median debt ratio rose to 63 percent last year from 52 percent in 2008.
- Among emerging economies, it increased to 21 percent from 15 percent.
There is a tradeoff between short-term benefits and medium-term costs of rising household debt:
- In the short term, increased household debt is likely to boost economic growth and employment.
- In three to five years, those effects are reversed: growth is slower than it would have been otherwise, and the odds of a financial crisis increase.
- These adverse effects are stronger at the higher levels of debt typical of advanced economies and weaker at lower levels prevailing in emerging markets.

A 5 percentage-point increase in the ratio of household debt to GDP over a three-year period forecasts a 1.25 percentage-point decline in inflation-adjusted growth three years in the future.
Higher household debt is associated with significantly higher unemployment up to four years ahead.
A 1 percentage point increase in debt raises the odds of a future banking crisis by about 1 percentage point.
Baseline probability of a banking crisis, without any increase in debt, is 3.5 percent.

Short-term mechanism: Households take on debt to buy durables (homes, cars), boosting demand, employment, and activity in construction and manufacturing.
Medium-term mechanism: Highly indebted households may cut back spending to repay loans, reducing aggregate demand.
Tail risk: A sudden shock (for example, a decline in home prices) can trigger credit defaults and a systemic financial crisis, as seen in 2008.

Structural and macroeconomic settings that reduce vulnerability:
- Countries with less external debt are better placed to weather rising household debt.
- Countries with floating exchange rates are better positioned to absorb shocks.
- Financially more developed countries have greater capacity to manage consequences.
Regulatory and distributional policies that help:
- Better financial-sector regulations reduce risk.
- Lower income inequality also mitigates vulnerability.
Direct measures to moderate household debt growth:
- Modify the down payment required to purchase a house.
- Limit the fraction of household income that can be devoted to debt repayments.
Overall: Good policies, institutions, and regulations can substantially ease the tradeoff between short-term benefits and medium-term costs; conversely, countries with poor policies are more vulnerable even if initial debt levels are low.

Rising Household Debt: What It Means for Growth and Stability — IMF blog, October 3, 2017

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