Suppose I have a mortgage payment that's equal to my weekly paycheck. But then after a few years of 1970's style inflation, my paycheck has doubled. Well, the mortgage payment is still the same. So now it only costs me

*half*a week's pay.

Existing debt comes to look smaller as a result of inflation.

If I may paraphrase Jazzbumpa:

Art wants to tell a story where debt growth has been on a continuously increasing trajectory through the entire post WW II period. Clearly this was the case, until the onset of the recent recession.

Jazz disagrees, showing this graph:

Graph #1: Household Credit Market Debt Outstanding relative to Wages & Salary Accruals |

Of this graph, Jazz writes:

The graph above shows there was an actual decrease in debt burden in the 60's, then only a slight increase during stagflation and the moribund Carter administration.

I responded to that, as follows:

True enough. BUT... (and I didn't figure out how to look at this yet)... there was Big Inflation in those years where debt does not rise a lot. I'm thinking, wages went up a lot and maybe additions to total debt went up a lot, but existing debt shrank probably a lot relative to the inflation of the time... and this is probably why the graph flattens out in those years.

This is what I want to look at: What does inflation do to accumulating debt?

I worked it out in an OpenOffice spreadsheet:

Suppose I start with debt equal to 50% of my income. And suppose I borrow an amount equal to 3% of my income each year, allowing this debt to accumulate. But beginning in year 5 and lasting to year 10, there is inflation and my income increases at 5% per year. Note that my new borrowing increases with my income, but my existing accumulation of debt is reduced by inflation.

Inflation reduces the burden of pre-existing debt. So even with new borrowing that increases in proportion to rising income, accumulated debt stabilizes as a portion of income.

If new borrowing increases at a slower rate than inflating income, accumulating debt will decline as a portion of income. This is the reason Jazzbumpa's graph shows "an actual decrease in debt burden in the 60's, then only a slight increase during stagflation".

The OpenOffice spreadsheet (download)

The Google Docs spreadsheet (view)

## 6 comments:

This is the reason Jazzbumpa's graph shows "an actual decrease in debt burden in the 60's, then only a slight increase during stagflation".1) It's not my graph, it's yours. I was responding.

2) It's not THE reason, it's A reason (I say it again.) Else there should be a consistently inverse relationship between debt burden and inflation.

Clearly, there is not, as a glance at the 90's vis-a-vis the naughts reveals. (This is the subject graph divided by CPI.)

Huge difference in the posted graph; not much difference in the linked graph.

Here's CPI - 90's and naughts up the the GR are essentially equal.

Sure inflation helps eliminate debt. That was conventional - and correct - wisdom for a long time.

But it is not the only thing going on.

Cheers!

JzB

You're good, Jazz. I know you're good because the first time I read your remarks I get torqued. I have to read them 2 or 3 times (over 2 or 3 days) before they make sense to me. And then they're just really interesting.

My graph is CMDEBT relative to WASCUR (household debt relative to wages & salaries). Your linked graph is the same, but divided by the CPI. Since CPI goes up, your version of my graph goes down. I get that. I'm not sure what the significance of your calculation might be.

I come back to this occasionally: I don't like to "correct" debt for inflation this way. I don't like to divide debt by a price index. I think debt is doubly-deflated that way, in error.

I'm not delighted with dividing by CPI,either. But a denominator provides context that is meaningful in this discussion.

If new borrowing increases at a slower rate than inflating income, accumulating debt will decline as a portion of income.This is a tautology, not an explanation.

But borrowing and inflation are both variable over time. In the 90's there was little change in Debt/Income while the inflation adjusted value actually declined a bit.

In the naughts, debt/income shot up dramatically, while the inflation adjusted value barely budged. Meanwhile, there was very little difference in CPI between the two periods.

{BTW, I'm having a really hard time wrapping my head around that.}

And you need to rethink think this:

I don't like to divide debt by a price index. I think debt is doubly-deflated that way, in error.Not so.

Cheers!

JzB

Maybe I'm misunderstanding the graph, but I agree that nominal debt divided by nominal wages should NOT be then divided by CPI.

The nominal debt already "equals" (("real" debt) * CPI)

And the nominal wages similarly "equal" (("real" wages) * CPI)

So the "CPIs cancel" and the graph is the ratio of debt to wages.

I don't think that dividing by CPI again gives you anything meaningful.

Nice, Jerry.

For me: If I borrowed $100 in 1972, that transaction originated in 1972 dollars. Today it takes maybe $520 to equal the purchasing power of $100 in 1972. But the amount of principal on that old loan is still just $100.

Typically, to "adjust for inflation" you divide the subject number by the price index. This "deflates" inflated prices.

But if I divide my old $100 debt that way to "correct" for inflation, the result is something like $20. I don't know what that is, but it's not a meaningful measurement.

I think what I mean (in that context) is, the wages are already inflation-correcting.

Say you were making $10k/year in 1972 and got the $100 debt, and let it sit until now. Say you are making the same "real wage" - now $52k/year. $100 used to be 1% of your salary but now it's like 0.2%.

So, $100 / $52k is already "deflated". it's 1/5th of what it would have been in 1972. In some sense.

If you divide it again and call it $20 then you're looking at $20/$52k, which is not right (0.04% or something instead of 0.2%). Because you're comparing the debt in 1972 dollars to the wage in 2011 dollars. Or whatever.

(i'm not disagreeing with you, just rephrasing my statement using your more clear example.)

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