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Finance

US household debt is rising — here’s why

US household debt is rising — here's why 1

Although the Federal Reserve has aggressively increased interest rates since early 2022, US household debt is rising. One might expect debt to fall as interest rates rise and borrowing becomes less desirable. However, household debt for Q2 stood at more than $16.15 trillion — an increase of around $2 trillion since the start of the pandemic. 

US households owe more than $16 trillion

Two years of loose Federal Reserve policy while the global economy struggled to come to terms with COVID-19 lockdowns have left their mark. In 2021, markets rallied as the central bank encouraged spending, and individuals stuck at home turned to retail-friendly trading platforms like easymarkets.com and others to buy and sell stocks with cheap debt and government stimulus packages. Yet, in 2022, the central bank has well and truly put the brakes on. 

Beginning March, the Fed has increased rates to around 2.33 and analysts are expecting more hikes to come. The increases come as inflation in the US rose as high as 9.06% in July. 

Demand for typically financed items such as homes and automobiles amid COVID-related supply shocks has put pressure on prices, contributing to the rising debt burden. Meanwhile, the War in Ukraine has driven up the cost of food and energy worldwide, only tightening household budgets. 

Interest rate hikes are intended to reduce borrowing and, therefore, spending — to bring inflation under control. Yet, those with existing debts often find themselves owing more, too. Refinancing mortgages and the increased cost of servicing debts can lead to even greater overall household debt — especially when set against today’s macroeconomic backdrop. 

Together, rising prices across the board have led to debt increasing from around $14 trillion in late 2019 to more than $16 trillion by the end of Q2 2022.

Household debt through history

Looking at historical data can shine a light on today’s situation. Household debt as a percentage of total disposable income has risen considerably since the mid-1980s. From 60%, the figure rose to 130% by the turn of the century. This outsized household debt was a key factor underpinning the 2008 financial crisis. 

From the 2008 peak, household debt fell quickly, and as the pandemic broke out, it stood at around 92%. Economist J.W. Mason argues in a paper for Barons that this rise in debt was actually not a symptom of an increase in borrowing but the high-interest rates introduced by Fed Chairman Paul Volker during the 1980s. Mason writes: 

“With higher rates, a level of spending on houses, cars, education and other debt-financed assets that would previously have been consistent with a constant debt-income ratio, now led to a rising one.”

The years after the 2008 crisis were ones of low rates. This, combined with reduced borrowing and defaults, led to a decline in household debts. 

Therefore, contrary to popular belief, today’s rising debt burden appears not to be driven predominantly by excessive borrowing but rather by the combination of rising interest rates intended to reduce borrowing. Mason concludes that a reduction in household debt requires both a drop in borrowing and low-interest rates. 

With the Fed apparently committed to further rate hikes going forward, it appears household debt will continue to rise in the short- to mid-term.   

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