Does Rising Consumer Debt Signal Future Recessions?: Testing the Causal Relationship between Consumer Debt and the Economy

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This paper examines the relationship between measures of the consumer debt burden and various economic indicators. The consumer loan delinquency rate is useful in predicting consumer spending on durable goods and retail sales, while various economic indicators are useful in predicting the ratio of consumer installment credit to disposable income. The results provide no evidence for the hypothesis that a rising consumer debt burden signals any slowdown in the growth of consumer spending and the economy. Instead, the results indicate that rising consumer indebtedness is a normal occurrence in an economic expansion. It remains to be seen whether innovations in credit card usage, along with the growing use of substitutes for traditional consumer loans, will have an impact on the causal relationship between consumer debt and the economy. (JEL E21, E32)


Policymakers, legislators, and economists alike have expressed concern about the rising consumer debt levels that occurred during the recovery following the 1990-91 recession. This concern is prompted, in part, by historically high levels for certain measures of consumer indebtedness. In 1996, total consumer debt reached record levels and continued to climb, and personal bankruptcies exceeded one million for the first time ever [Epstein, 1997]. This has led policymakers and financial analysts to question whether the cost of interest and principal payments will cut into other expenditures, weakening consumer spending and halting economic expansion [McNamee and Melcher, 1997]. Higher debt levels in these years are due to both supply factors and demand factors: Banks are increasingly aggressive in marketing credit cards, especially to lower income households, while consumers are increasingly willing to use them [Black and Morgan, 1998]. The higher levels of durable expenditures along with the borrowing to finan ce them are normal during the expansion phase of a business cycle. When combined with the increased availability of credit cards, record levels of consumer debt are not surprising [U.S. House of Representatives, 1996].

The questions remain as to whether growing consumer indebtedness is a threat to an economic expansion and whether debt levels affect the duration and severity of recessions. In other words, is there a relationship between measures of consumer debt and measures of economic performance? Do increases in consumer indebtedness predict decreases in the gross domestic product (GDP) or other economic indicators?

Since the growth of consumer installment financing in the 1920s, rising levels of consumer indebtedness have periodically prompted concern from the government and the financial community. Research on the relationship between consumer indebtedness and the economy dates back to the 1920s, when large increases in the production of consumer durables gave way to the development of consumer installment credit to finance durable good purchases. Consumer debt increased dramatically in the 1920s after relative stability in the two previous decades, prompting concern about the future of "the economic and moral bounty provided by the steadfast adherence to the value of thrift" [Kubik, 1996, p. 832]. Economists were also concerned that large consumer debt burdens would exacerbate the business cycle, causing an overexpansion of consumer durable production during prosperous periods and causing large falls in consumption during economic downturns [Danielian, 1929]. Kubik [1996] contends that the concern over rising consume r installment credit in the 1920s shaped the opinions of Federal Reserve officials toward debt and asset liquidation during the first two years of the Great Depression. Mishkin [1978] claims the large levels of consumer debt played a crucial role in the decline in consumption expenditures following the stock market crash in 1929.

In the 1950s, the potential of consumer credit to intensify business cycles was again a cause for concern. …