Academic journal article Federal Reserve Bank of St. Louis Review

On the Macroeconomics of Private Debt

Academic journal article Federal Reserve Bank of St. Louis Review

On the Macroeconomics of Private Debt

Article excerpt

During the 1980s, private-sector borrowing expanded to such an extent that many analysts became concerned that the accumulated debt would be a drag on spending, making the recession worse if and when it occurred and slowing the ensuing recovery.

This article examines the role of private nonfinancial debt in the U.S. economy after putting recent debt trends in perspective and discussing the economic role of debt, Carlson considers the macroeconomic effects of debt. He finds that economic activity almost always leads the debt cycle; debt seems to respond to the business cycle rather than the other way around. Furthermore, movements in total spending do not appear to have been systematically related to debt/income ratios over the past 40 years.

EARLY LAST YEAR, a survey of the 50 Blue Chip forecasters indicated that the most important factor influencing the outlook for near-term economic growth in the United States was the debt burden carried by governments, households and businesses.(1) Debt and borrowing are common features of economic life, yet not everyone agrees on their role in the economy because borrowing can be viewed either positively or negatively. It is considered prudent to borrow to take advantage of an investment opportunity, but it is considered unwise to borrow simply so that you can consume beyond your means. Consequently, concerns about debt can arise when credit is not available, as well as when it is too readily available. In this sense, debt is a lot like money; it can cause problems when it grows too slowly, as well as when it grows too rapidly.

The current concern in the United States, however, is that the volume of debt has built up so much that it is a drag on spending, thereby dampening the economic recovery.(2) Such a concern applies to all economic units, both private and public. But to limit the discussion here, the focus is private debt--that is, the accumulation of past and present borrowing by households and private (nonfinancial) business.(3) During the recent recession, the term balance sheet restructuring has been used to describe the process of businesses and households adjusting their assets and liabilities along with their spending and saving in an effort to lighten debt loads.

The focus of this article is the role of private nonfinancial debt in the economy. Some perspective will be provided on debt's growth, magnitude and composition, along with some explanations of why these trends have occurred and additional consideration of their economic effects. The question of when and why debt becomes a burden is also addressed.


Figure 1 illustrates the basis for recent concern about the burden of debt as it relates to the private nonfinancial sector. In figure 1 the major categories of private debt are expressed relative to gross domestic product (GDP). Debt is defined as credit market debt (at par value) owed by households and domestic nonfinancial businesses as presented in the Federal Reserve flow of funds.(4)

The amount of private nonfinancial debt in the economy, the top line in figure 1, rose from 101 percent of GDP in 1981 to 132 percent in 1990 before declining in 1991. Debt of both sectors--households and businesses--rose substantially during the 1980s, although the patterns of growth were different. Of the 31-percentage-point increase in this debt/GDP ratio from 1981 to 1990, the household sector accounted for 18 percentage points.


Being in debt is so common that the average person gives little thought to the role of debt in the functioning of a free-market economy. Reasons for borrowing vary greatly among economic units, but the way these diverse borrowers interact with lenders and exchange funds is what interests economists. Financial markets encompass all types of transactions involving flows of funds between borrowers and lenders or exchanges of existing debt. …

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