The broader household financial measures, such as the financial assets/ liabilities, net worth, and the stock market appear as clear, useful measures to forecast future consumption spending as well as future GNP. They do not suffer from any feedback effect and the results are consistent for both informativeness tests. In summary, the broader measures of consumer finance appear well suited to forecasting consumption. Both consumer debt measures and the assets/ liabilities and stock market measure appear useful in forecasting future GNP.
Different views are expressed regarding the relationship of consumer debt to economic activity. Everyone hates their liabilities and loves their assets. Designated as a liability, consumer debt surely is to be hated. Future interest and principal payments detract directly from the debtor's income stream. In the extreme, debt and the payments that debt mandates have the ability to impoverish. But debt also allows individuals and companies to acquire assets they otherwise could not have obtained and to consume outside the constraints of their current income. In order to evaluate debt, we have to know the purpose to which the proceeds were used and the ability of the borrower to service the debt.
The maximum amount of debt that a consumer could incur without going bankrupt is limited by the discounted present value of his future income plus current net worth. Changes in the income path, interest rates, and current asset values will clearly affect the consumer's debt capacity.
A consumer's debt capacity is determined, in part, by market conditions. Lenders, in the presence of adverse changes in interest rates and market expectations about their future income, will alter their lending limits in order to reduce consumer bankruptcy risks. These changes will tend to bring the economy's debt ratio in line with the new market conditions. In principle, the adjustment could lead to a disruption in the financial market that would, in turn, bring about a retrenchment in the economy. This suggests that changes in consumer debt could be used to forecast the future path of the economy.
Increased real wealth reduces the need to save and thereby lowers the household savings rate. This analysis suggests that changes in aggregate asset values in conjunction with the debt to income ratio provide a much clearer picture of the conditions under which a change in debt is a vice or a virtue.
YFXt = YPXo (l + r)t