Monday, November 20, 2017

The return and maintenance of economic vigor

I started predicting vigor in March of 2016. Then in July 2016 I showed a graph of Household Debt Service Payments at a low point and ready to rise:
I called vigor because financial costs are down:
Graph #4: The Fall and Rise of Household Debt Service Payments
Financial costs have fallen from 13% to 10% of Disposable Personal Income. And now consumers have 3% of DPI to play with. Look at the extreme right end of the blue line on the graph: The line is starting to go up again. Already.

In March I said "We are at the bottom now, ready to go up." Four months later I showed it going up. Debt service is starting to go up again already, I said.

But then, a year after my original prediction of vigor, commenting in March 2017 on the graph shown above, I said

The uptick at the end of Graph #4 seems to have fizzled out. The link shows TDSP thru the end of 2016:

Unfortunately, I wasn't clever enough to capture the graph as an image, and TDSP has since changed. The link in my comment doesn't show what I was looking at in March of 2017, which was something like the red line here:

Graph #1: Household Debt Service as of March 2016 (blue) and March 2017 (red)
The tiny uptick at the right end of the blue line was gone (or perhaps just slightly lower, now that I see this comparison!) and the newer data was flat. But I was still confident. "Vigor will come," I said.

When I looked just now at the graph linked in my March comment, it was the current version. The data had been revised, and the flat end was gone. Debt service is rising again. It is struggling to rise (as you might expect following a debt crisis, while people remain cautious) but it is rising. I marked up an interesting similarity:

Graph #2: Household Debt Service as of October 6 2017
Two very brief, very tiny maximums in the data, one after each major decline.

I expect what happens after the second tiny maximum will look a lot like what happened after the first: uptrend, a sign of economic vigor. And since the more recent major decline is much bigger, I expect the uptrend will also be bigger this time. We will see economic vigor again, for perhaps a decade.

All that remains is for us to take advantage of the good years: Use the time to prevent another decade of bad years. All we need to do is limit debt growth to something sustainable. Better yet, we should seek the debt-to-GDP ratio that's most conducive to growth. We want to be like a surfer riding a wave of debt, where the wave carries us forward at speed but does not grow to the size of a mountain.

It can be done. To have a vigorous economy, we need lots of borrowing (and that day is coming). But lots of borrowing creates lots of debt. The obvious solution is to pay down debt: to pay down debt faster than we have done in the past. We need policy to make that happen.

Accelerating the repayment of debt may slow the economy some. But so does raising interest rates. We can use accelerated repayment of debt as an anti-inflation policy, along with the interest rate hikes that policymakers already rely on. If accelerated repayment is used, rate hikes will be needed less. And debt will be lower.

But there is something else: Raising interest rates affects all new borrowing, and that curtails economic growth. That's not the best outcome. Accelerated repayment of debt, on the other hand, affects people who have already borrowed. It only slows the economy for those people. People planning to borrow are not hindered by this new approach to inflation control, so economic growth is less severely reduced.

The new policy has to allow for the fact that we're starting with a high level of debt. It must reduce debt gradually, so that people are not thrown into crisis by it. That may seem to defeat the purpose, but it does not. As long as debt is going down, we're on the right track. And almost immediately after the level of debt begins to fall, the economy will begin to improve.

We never had policy that accelerates the repayment of debt. That's the reason private debt got so big. We have lots of policies that encourage the use of credit, and none to encourage repayment. To make policy more balanced, more sensible, we need policies that accelerate the repayment of debt. This way we can keep policies that encourage credit use (and enjoy the growth that results from those policies) but avoid having debt grow to an unsustainable level.

We still do have a mountain of debt to deal with. Some people might worry that "accelerated repayment" would make life difficult for debtors. But there is no reason the policy should be punitive. At the start, the new policy must help us reduce our debt: It must not be punitive. Once debt falls back to a level that is compatible with a vigorous economy (and stabilizes there) the policy can be made neutral. It need never be punitive.


jim said...

What the Household Debt Service Payments graph clearly shows is that Congress had an effective policy in place for reducing the burden of debt to housefolds. That vertical step that you see in the graph at the start of 2013 is due entirely to the change in tax law that went into effect Jan. 1,2013. That tax increase not only suddenly created a huge increase in debt burden, it also permanently changed the trajectory of the graph. Without that change in tax law, I expect the debt burden to households would have fallen to around 5%-6% before turning around.

The Arthurian said...

Hi Jim. I remember you pointed out that vertical step before. The timing is certainly right. But I don't follow the causal logic. Why would a tax increase cause debt service to fall more slowly? Maybe because if taxes go up, then disposable (after tax) personal income goes down. And if debt service (in dollars) remains the same, then debt service relative to DPI goes up. Okay... But I have no confidence in the causal explanations I can come up with.

jim said...

Hi Art
Household disposable income is income minus taxes.
Household disposable income dropped 4% from the last quarter of 2012 to the first qtr of 2013. Compare that to the worst quarter of the Great recession that saw household incomes drop 1.3% which as far as I can see was the previous record low for biggest loss of disposable income in a quarter.

Without the sudden tax increase Household disposable income would have probably grown 1% that qtr as it had been averaging for the previous 8-10 quarters.

That tax increase is the sole cause of the sudden increase in the household debt service ratio. The permanent change in trajectory of the graph is a little more complicated. It looks like it is a combination of slower income growth after the tax increase and slower deleveraging. Both can be traced back to the tax increase. Less household spending brings forth less household income and less ability to reduce debt and more accumulation of debt to augment spending.

The Arthurian said...

I get it now. Good explanation. You seem to be saying that the up-turn in Debt Service is not necessarily a sign of economic vigor, but a failure of ceteris paribus. The debt service ratio is rising not because spending & credit-use are rising, but because income shifted downward, changing the trend of debt service.

This is an interesting evaluation of my expectation of vigor.

The Arthurian said...

I'm not sure it matters, Jim. I see that the change in household debt (in billions) as a percent of Disposable Personal Income is back up almost to the level of 1991-92. It only needs to rise another half a percentage point to reach the level of the 1994-1998 period (the "good years").

Whatever the reason for the increase in borrowing, the result is still a boost for the economy. The credit-use still adds to household spending.

jim said...

I wasn't saying debt service ratio would go to zero. It would reach a bottom anyway
What is obvious to me is that without that tax increase the point where it turned around would have been much lower due mostly to incomes being higher.