Cheap Debt

Over the past several decdes, household debts have risen considerably over the past several decades. Even though households carry more debt, they don’t spend considerably more in debt repayments. Debt is cheap.

How cheap is debt? The figure below depicts US lending rates since 1960. Data come from the World Bank.1



Debt was quite cheap in the early-1960s, with lending rates that stood around 4.5%. Beginning in the late-1960s, the cost of debt started to rise. By the 1970s, lending rates had roughly doubled during a period in which general prices were rising quickly and the financial system had trouble delivering credit to those who wanted it. Borrowing troubles eventually became a point of contention in US politics, which ultimately culminated in major changes to credit markets under the Reagan Administration.  Lending rates peaked at nearly 19% in 1981, a period in which the Federal Reserve’s actions to staunch inflation caused a major tightening in credit markets. Since 1981, lending rates appear to have been in steady decline, before reaching very low rates after the 2009 crisis.


  1. World Bank (2015) World Development Indicators Data downloaded June 2015 at

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The Engines of Economic Growth

We know that economic growth has been lackluster for several years. Why is this happening? One way to address the question is to look at different economic sectors’ contribution to overall growth. The figure below looks at overall economic growth since 1950 (top panel), and four sectors’ contribution to that growth:

  • Private consumption, which includes purchase of services and consumer goods by non-government enterprises
  • Private investment, which includes non-government actors’ purchases of equipment, buildings, intellectual property, and residential homes
  • Net Exports, which is total exports minus imports
  • Government Consumption and Investment, federal, state and local government’s consumption and investment.

Data come from the Bureau of Economic Analysis.1



Some points of note:

Consumption-Driven Economy. Economic growth is primarily driven by consumption spending by both households and businesses. Until the 2008 crisis, private consumption contributed between two and three percentage points of GDP growth every year. Since 2008, mean private consumption has been about one percentage point lower than the historical norm. Our present economic slowdown is substantially driven by the fact that people and businesses are not consuming as much as they did earlier.

Private Investment Low for Years. The present economic slowdown is also partly attributable to the fact that private investment is lower. People aren’t buying as much equipment or building as many buildings as they had in past decades. Interestingly, private investment has been generally low for the better part of the past 15 years. This dip in private investment preceded the Great Recession.

This low investment level is noteworthy, as many of the pre-crisis 21st century’s tax cuts and deregulation were sold to the public as a means of stimulating prosperity by inducing more investment. Investment was a much more important engine of prosperity in the 1990s, possibly due to investments in IT equipment (equipment purchases surged from 1993-2000). By the 2000s, private investment dropped substantially, despite the fact that economic policies had pressed tax cuts, financial deregulation, and other policies that were sold as spurring the economy by promoting investment.

Trade a Minior Contributor. Net exports have generally made only minor contributions to overall economic growth. It has not been an engine of economic prosperity over the entire post-WWII era.

The Effects of Austerity. This series was particularly interesting. During the very prosperous 1950s and 1960s, public sector consumption and investment made large contributions to economic growth, providing just under one percentage point of economic growth. Government spending fell during the 1970s, alongside general economic growth. After the crisis, government spending has on average been a source of stagnation – it has lowered GDP growth. This illustrates the argument that austerity is hurting the economic recovery.

The table below presents mean percentage point contributions to overall GDP growth by decade, across sectors, from 1950 to 2014:

Sectoral Contribution to GDP Growth, in Percentage Points, 1950 – 2014

Sector 1950s 1960s 1970s 1980s 1990s 2000-7 2008+
GDP Growth 4.1% 4.3% 3.2% 3.4% 3.5% 2.5% 1.1%
Private Consumption 2.2% 2.6% 2.0% 2.2% 2.4% 2.0% 0.9%
Private Investment 0.8% 0.8% 0.8% 0.7% 1.2% 0.3% 0.02%
Net Exports -0.08% 0.04% 0.3% -0.2% 0.4% -0.4% 0.3%
Government Consumption & Investment 1.1% 0.9% 0.2% 0.7% 0.2% 0.4% -0.02%

  1. Bureau of Economic Analysis (2015) “Table 1.1.2. Contributions to Percent Change in Real Gross Domestic Product” Data table downloaded June 7, 2015

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Long-Term Trends in Corporate Profits

Over most of the late-20th century, corporate profits fell in proportion to the overall economy, but it has roared back since 2000. One can interpret these changes in several ways.

Figure 1 (below) describes changes in the ratio of US corporate profits to GDP from 1945 to 2013. Data are from the Federal Reserve:1

US Corporate Profits


The graph suggests that corporate profits fell steadily between World War II and the mid-1990s, but rebounded after 2000. Concretely, this means that corporations collectively took in progressively less operational profit between the end of World War II until 2001, relative to the overall value of what the economy produces. After 2001, corporate profits grew in proportion to overall economic activity. How might we interpret this trend?

One possible interpretation focuses on distributional struggles between corporations and other societal actors. During the 1940s through 1970s, economic policies tended to be more progressively redistributive. They taxes and regulated corporations more heavily, and were quicker to implement policies that redistributed wealth or bestowed bargaining power to workers and consumers. These policies are said to have been widely dismantled under neoliberalism and globalization of the 1980s through 2000s, which has led corporate profits to rise. This story line involves corporations losing a distributional battle with workers and consumers for decades, then an abrupt reversal of fortunes to our present situation in which they are now winning this distributional battle.

Other perspectives interpret these changes as a product of businesses working less well under postwar “big government” capitalism, then turning around to do great business after the Reagan Revolution and globalization. This narrative stresses the ways in which government taxes, spending, or regulations cause businesses and society to waste resources, suppress innovation, or focus on the ways in which lobbying for political favor becomes more important than being economically competitive. Here, the focus is on profit as a byproduct of fielding successful businesses, rather than a matter of redistribution. Through this view, one might infer that neoliberalism and globalization slowed American business’ precipitous fall into decrepitude, and ultimately set it on a path towards renewed profitability.

One explanation that interests me involves the erosion of America’s postwar position of international economic dominance. Most highly developed countries emerged from World War II greatly weakened, while the US economy and society remained largely unscathed, well-resourced, and ready to capitalize on the great technological advancements of the wartime era. American businesses did not face the strong foreign competition to which they are now subject, and America was well-positioned to dictated very favorable international economic terms with other countries. As the other Western countries recovered from the war, and became better able to assert themselves in the market and in international affairs, America’s competitive advantages eroded and its businesses found it harder to earn big. This explanation does not discuss why profits recovered after 2000.

Other explanations are possible. Whatever the reason, it seems clear that corporate profit shrank in proportion to the overall economy up until the 1980s or 1990s, and has slowly but steadily grown since then.

  1. Federal Reserve Board (2014) Series A464RC1A027NBEA and FYGDP from Federal Reserve Economic Data set. Accessed in Spring 2015.

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Housing Prices Since 1975

Housing is generally the biggest asset on people’s balance sheets. Those with money tend to own homes, and home owners are generally deeply invested in their houses. For many years, housing prices rose, and these price rises made major contributions to the middle and upper-middle class’s asset base.

Those who owned houses during this boom benefited with increased wealth, but the rise in home prices also made it more expensive to buy a home. Up until the 2008 crash, many of the families who were not able to get in on the housing market “at the ground floor” made their way in by using a range of new debt products that a booming financial market was offering. It became easier to purchase a home with no downpayment. People could get bigger mortgages if they agreed to gamble on adjustible-rate mortgages. Eventually, some people didn’t even need documentation to get a loan. Once credit got that loose, it was only a matter of time before some major problem emerged.

When the housing bubble eventually burst in 2008, both lenders and consumers became more reluctant to buy new homes. The market dried up and housing prices crashed. Presumably, this crash meant that more people could get into the housing market, although it might have ultimately hurt the wealth accumulation of home owners.

How much did housing prices fall? How much affordable did houses become? How much damage did home owners have to absorb? One way to address these questions is to look at changes in housing affordability over time. The figure below describes changes in the Case-Shiller price index.1 The index measures home prices in 20 metropolitan areas, and expresses itself as a relative price level to that which prevailed in January 2000.2



In 2014, housing prices were about 65% higher than in 2000. This represents a modest recovery of about 19% from the trough in housing prices in 2011. However, it still represents 10% lower prices than those that prevailed at the peak of the housing boom in 2006. So housing prices have not recovered. Homeowners who bought near the peak of the last bubble are still in the hole, and those who were counting on home values returning to their 2006 levels are still behind in their financial plans.

The graph also imparts a sense of the 2007-9 recession’s impact on home prices. Home prices fell by about 24% from the 2006 peak to the 2011 trough. That is a considerable amount of lost wealth, particularly because homeowners are generally deeply invested in their homes.

Regardless of the ups and downs of recent years, housing is far more expensive than it was thirty years ago. Prices in 2014 have more than quintupled over the past forty years. Meanwhile, incomes have not.

  1. Data from Federal Reserve Board (2015) “S&P/Case-Shiller U.S. National Home Price Index©” Data series CSUSHPISA downloaded June 9, 2015.
  2. S&P Dow Jones Indices (2015) S&P/Case-Shiller Home Price Indices: Methodology Methodological report.

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The Long Consumption Boom, 1980 – 2014

Any attempt to explain US households’ financial struggles must engage the issue of rising spending. While income stagnation is almost certainly part of what is causing households’ money problems, it is only a partial explanation at best. “Stagnation” means not growing quickly – it does not imply that household incomes have necessarily been shrinking (although they often have done so over the past several years). Even if incomes are stagnating, people should be able to maintain their savings by restraining their spending.

The problem is that households generally have not tightened their belts when faced with earnings difficulties – at least not until the Great Recession. The first figure below depicts changes in average personal income and expenditures for the United States from 1921 until 2014. All values are denominated in inflation-adjusted 2014 dollars.

At first glance, the graph suggests that average incomes have generally outpaced average expenditures.However, a closer look reveals that the space between disposable incomes and expenditures has been shrinking. In other words, the average American was spending more of their take-home pay.

This space can be seen more clearly in the figure below, which depicts the ratio of mean per capita total expenditures to disposable incomes. As noted in the previous chapter, the typical household saves about 10% or so of the take-home pay, but spending grew steadily – relative to income – and households were putting aside pennies on the dollar right before the Great Recession. Household savings rebounded after the Recession, but it was to savings rates that prevailed in the early 2000’s, not the 1970s.

These shifts of 5 to 10 percentage points in household savings rates translated into substantial differences in the amount of money people were putting aside from year-to-year. In the late 1950s, the average household put aside about $1750 (at 2014 prices) yearly. With the passage of time, households found themselves able to put aside more money, and by the early 1970s the typical household was putting aside over $3000 (again, at 2014 prices). However, per capita savings fell steadily over the ensuing decades. Even though the average person earn far more money in 2005 than in 1970, Americans typically put aside three times as much from year-to-year. Savings did rebound after the 2008 Crisis, even though people should be putting aside much more money today – retirement, health care, a college education, and many other living costs are much higher today than 40 years ago.

More spending is undoubtedly part of what is causing US households’ money problems. One might argue that, in an age of Walmart, Costco, and cheap Chinese imports, it has never been so easy to save money. Yet people are not saving money. Any endeavor to explain US households’ financial insecurity must engage over-spending.

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