Is Monetary Policy Being Thwarted by Consumer Debt Overhang Ending?

November 29th, 2012
in econ_news, syndication

For the consumer, the Federal Reserves low interest rate policy (ZIRP) has not be beneficial - especially among older Americans who have seen their income from CD's vanish.  There is evidence recently of a very modest resurgence in consumer's use of credit.


Follow up:

What Drives Consumer Debt Dynamics? - A study by Edward S. Knotek II and John Carter Braxton at the Kansas City Fed believes a modest rebound in consumer credit is underway.

Consumers generally have been reducing their debt levels in the wake of the housing bust, and many policymakers and economists have pointed to this deleveraging as an important drag on the recovery from the recession.

A key driving factor has been the sharp decline in the number of consumers taking on additional debt. With fewer borrowers taking advantage of low interest rates to take on debt and expand spending, accommodative monetary policy is less effective than in normal times.

But Knotek and Braxton find that a modest rebound is now under way in the number of consumers increasing their debt. The trend is evident across geographic regions, including areas that experienced strong debt growth during the housing bubble, suggesting that debt overhang may be playing only a limited role in the consumer debt dynamics of the recovery.

This study concludes:

Consumers have been reducing their debt in the aggregate in the wake of the housing bust and financial crisis. While a portion of this deleveraging has come from defaults and foreclosures on mortgage debt, a key driving factor has been a sharp decline in the number of consumers taking on additional debt. This decline has been widespread, as virtually all types of consumers—high- and low-income, high- and low-risk, those living in high-debt regions and low-debt regions—have reduced their borrowing activity since the early to mid-2000s.

While the number of consumers increasing their debt remains at low levels, it has recently begun to recover modestly. Part of this rebound is coming from consumers who experienced the sharpest declines in borrowing activity, including consumers from lower-income areas and consumers with higher credit risk. Such a pattern is consistent with some easing of tight credit standards. By contrast, geography and debt overhang from the housing bubble appear to be playing a limited role in consumer debt dynamics in the recovery.

With relatively few borrowers taking advantage of historically low interest rates, accommodative monetary policy is less effective than in normal times. Ultimately, ending the deleveraging process will require a broad-based expansion in the set of borrowers who both demand and can service additional debt.






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