Saturday, February 16, 2013

Low interest rates are one thing. Low accumulated debt is quite another.

I took an old copy of Mason and Jayadev's Fisher Dynamics PDF and snapshotted Figure 2 -- a graph which shows (among other things) the nominal effective interest rate on household debt. From the paper:

The effective interest rate i is total interest payments divided by the stock of debt at the beginning of the period.

I used MS Paint to add gridlines to the graph. (To keep the lines running square to the graph I used the "rectangle" tool.) Got this picture. Then I guessed the numbers and created a table of "Effective Interest Rate" data. Annual data.

I s'pose it would have been easier to ask Mason for a spreadsheet. Maybe next time.

Okay. So let's pretend all debt bears interest at the effective household interest rate figured by Mason and Jayadev and jiggered by me. Well, Federal debt probably has lower rates. For "all debt" I'll use Debt Other than Federal Debt for 1980-2010, same years I took from Mason and Jayadev.

I downloaded the data from this FRED page. (The linked page shows the same data as my recent Debt Other than Federal Debt graph, but annual numbers this time.)

Here's what I got for Total Effective Interest Paid in Billions:

Graph #1

Up it goes, till the crisis... Here's the same data, relative to GDP:

Graph #2

First reaction? It's high, but it's all over the place!

Rebound reaction? Wow, I have to do the years before 1980!

Turns out that the early-90s decline, the early-2000s decline, and the late-2000s decline on Graph #2 all match up with declines in interest rates:

Graph #3

But aside from the times when interest rates were rapidly dropping, the general trend of interest rates was down, and the general trend of interest payments was up. Why? Because debt was accumulating. We were paying interest on more and more debt.

Graphs & data contained in this Google Docs spreadsheet.


nanute said...

What a great idea for a post! lol. I'm not sure what the data means but I did notice the following: Interest paid in 1980 403 billion. 2007 3,041 billion. Interest rate in 1980 was 10.5% and in 2007 6.9%. During the same time period the Fed Funds rate in 1980 was 13% and in 2007 it 5%. More importantly, I think, is look at where the Fed funds rate is now relative to the consumer interest rate average. If ever there was a strong argument for private debt relief this would be it. It is frustrating, isn't it?

The Arthurian said...

Damned ignorant is what it is, if they think lowering interest rates makes up for a massive accumulation of debt. The two are so obviously related, and policy-makers focus so intently on interest rates, but so intently ignore the level of private debt.

Mason would likely not be impressed with my crude use of his graph :)

Greg said...

One other thing. When your interest rate gets lowered, your payments go down but the time for payment goes way up. So you end up indebted longer. Yes you are paying a lower percentage of your income (maybe) but you are in total paying way more back. More people wish to be out of debt earlier not just paying smaller debt payments forever!

Debt relief as the banks see it is not really relief. They are like a guy who is choking you then easing up a bit and letting you breathe a little bit longer, but you are still being denied all the air you could get without their hands on your throat. They are just killing you slower!

The Arthurian said...

"They are like a guy who is choking you then easing up a bit..."

Now there's an analogy that grab's ya!

nanute said...

Greg, That's certainly true. But by the same token, it just might make it more affordable to pay off the debt sooner. Or free up capital for other investments or spending. I'd much rather see a true debt forgiveness type of arrangement, but realism tells me that ain't gonna happen.