... changes in borrowing behavior have played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of “Fisher dynamics” — the mechanical result of higher interest rates and lower inflation after 1980.

The year-to-year change in household debt is a measure of the money households borrow into existence and spend into circulation. An increase in household debt is an injection of funds into the money used as a medium of exchange.

But, to state the obvious, an addition to debt adds to debt. And debt must be repaid with interest. Interest is a cost that takes money and moves it from the productive sector to the financial sector. While it remains in the financial sector, the money is not used as a medium of exchange -- not, at least, in the productive sector.

So we can say that an addition to debt increases the money available for spending, and interest payments reduce the money available for spending. If we take one year's addition to debt and subtract from it the payment of interest for that same year, we can calculate a "net change" in money available for spending due to household credit use. Figure it for a number of years, and we can make a graph showing the history of the net change over time.

But the values on such a graph will be influenced by the rate of inflation. The graph will be malformed because the rate of inflation varies. As we are thinking about growth, we must remove the inflation. We can remove it by the same calculation used to remove inflation from "nominal" GDP.

However, I want to use the CPI as the measure of inflation, rather than the Deflator, because we're looking at household debt and household interest costs.

All of this can be done at FRED with a minimum of fuss:

Graph #1: Net Change in the Medium of Exchange due to Household Debt The description of the calculation (in the upper blue border of the graph) has been cut short by a devious and disappointing FRED. The full description is "(Households and Nonprofit Organizations; Credit Market Instruments; Liability, Level-Monetary interest paid: Households and nonprofit institutions)*(100/Consumer Price Index for All Urban Consumers: All Items)" |

Before 1980, the line is mostly above zero, indicating a net increase in the circulating medium, a boost for spending and growth.

Between 1980 and 2000 the line is mostly below zero, indicating a net decline in the circulating medium due to the cost of interest.

The graph supports JW Mason's statement.

## 3 comments:

Art

Like the graph, tweaked it up a little. Seams to suggest recessions come when the line move to zero.

https://fred.stlouisfed.org/graph/?graph_id=406877

"recessions come when the line move to zero"

Yeah. There is a little of that in my original graph, but not so much.

I was surprised to see yours trending up and up. Mine runs mostly above zero, then mostly below zero for a while. When I looked closer I see you are adding

change inRGDP (billions). That's why. (I was thinkingpercent change.)M1 Velocity went from 6.3 in 1995 to 10.6 in 2007. All high numbers, and a big increase. In those years RGDP increased from 6.3 to 10.6 times the quantity of M1 (give or take because I used CPI, not the Deflator). The component of M1 which my graph measures is only part of M1, generally less than 20%. So GDP would be about 30 to 50 times the size of the net change in money available for spending due to household credit use.

If GDP grew 10% annually, your graph would add an amount 3 to 5 times the size of my "net change" numbers. So, half that, say. You are adding at a minimum 1.5 times the number I started with. (This is all just rough & in-my-head. If you can't follow my thoughts I apologize.)

Your change to my graph is bigger than the numbers I started with. So I think that accounts for your graph looking so different from mine. Also, the big increase in velocity (1995-2007) would help to explain why your graph runs high in those years while mine (till 2000 anyway) runs low.

Well that was fun!

ART see Order of Operations. I think I need to re-do the graph.

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