Has the role of debt in our economy fundamentally changed? Some have identified a rise in the ratio of consumer credit to GDP as a sign that debt has taken on a more harmful aspect, fueling unbalanced economic growth. The ratio of consumer credit to nominal GDP was about 18 percent at the end of last year, not much changed from 17-1/2 percent 10 years ago but up from roughly 12 percent 10 years before that.
But how significant is that change? A glance at our chart to the left showing the paths of nominal GDP and credit suggests a pretty constant relationship over the last seven decades. In fact, the levels of nominal GDP and consumer credit exhibit a 99 percent correlation since 1947. That seems to suggest that whatever the role of consumer credit in fueling economic growth, it hasn’t changed much in the last 66 years.
Things look a little different when you consider measures of credit that include loans secured by real-estate, including mortgages and home equity lines of credit. There we see a clear and unprecedented change of gears starting around 2000, with household liabilities reaching a peak in 2007. However, the correction back down since then has been dramatic, and the evidence suggests it has not yet run its course. Even considering the mortgage-fueled debt bubble of the early 2000s, the correlation between overall household liabilities and GDP over the last seven decades is still 98 percent.
With a longer-term view, we can see two major shifts in the ratio of consumer debt to GDP—one in the 20-year period from the mid-1940s to the mid-1960s, and another in the roughly 25 years from the mid-1990s to today. During both of those periods, the ratio of consumer debt to GDP rose, but not by enough to disrupt the longer-term relationship between the two.
There are a number of factors that may have contributed to these shifts, such as prolonged periods of low interest rates, or changing patterns of household income growth. It’s possible that we will enter a new period of stabilization in the consumer debt-to-GDP ratio, such as occurred from the 1960s to the 1980s. Or perhaps the ratio will continue to rise. It’s too early to judge—households’ balance sheets, and the economy overall, are still recovering from the financial crisis and Great Recession.
Another way to think about household debt is in relation to household assets. As our chart to the left shows, there has been a decline over time in the ratio of households’ assets to their debt liabilities—in other words, households’ assets have not grown as fast as their debts. But again, seen through a longer-term lens, the recent experience hasn’t been that striking. While there was a clear drop in households’ assets relative to their indebtedness leading up to the Great Recession, there has been substantial improvement since then. In fact, the drop over the last 60 years is much less striking than the decline in the 20 years before that.
We should keep in mind that these are aggregate data, for the economy overall. The story may be more nuanced if you examine the results by household income or assets, or even by geographical region. But in thinking about the role that consumer debt plays in our economy overall, the evidence does not support the conclusion that we are now on a fundamentally different track than prior to the buildup of the financial crisis.
Consumer debt and economic activity are closely correlated. Shifts in that relationship are not unprecedented, but they are more equivalent to, say, adjusting the mixture of fuel and oxygen in your car’s gasoline engine rather than getting a whole new engine—or a whole new car.