Public & Private Debt
A few weeks ago at the Conservative Party David Cameron’s speech looked set to contain a call for households to pay off their debts. Thankfully the Prime Minister dropped this line a few hours before his address.
I can’t think of a time that a major political leader has ever stood up and essentially argued – ‘we face a renewed risk of recession – therefore you should probably spent less’, if an opposition figure made the same case they would undoubtedly be accused of talking the economy down’.
But what makes this call doubly odd is that the Office of Budget Responsibility’s forecasts are premised on a large rise in personal debt. They forecast household borrowings to rise from £1,560bn in 2010 to £2,126bn by 2015, an increase of 36.3%.
A point that is emphasised by a new report from investment bank Citi (via Ft Alphaville in a generally superb post on debt). The chart below shows the reduction in reduction in government debt (the blue line) and the increase in private sector debt in 13 ‘successful’ cases of fiscal consolidation.
As can be seen in 8 of the 11 cases for which there is data the reduction in public debt was accompanied by an even larger increase in private sector debt. In some cases a very much larger rise!
The problem the government currently have is that households (and firms) don’t seem to want to increase their debts. Instead they want to ‘deleverage’ or pay them down – meaning less spending in the economy and slower growth.
The economist Richard Koo has termed this a balance sheet recession:
Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Japanese firms overall became net savers after 1998, as opposed to borrowers. Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type Great Depression, in which U.S. GDP fell by 46%. He argued that monetary policy was ineffective because there was limited demand for funds while firms paid down their liabilities. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy
Right now there is a lot of evidence that British household’s and firms want to reduce their debts, something which the analysis of Richard Koo and the empirical evidence from the graph above suggest is not compatible with the government cutting its own borrowing.