Household debt must be reduced, says study
DESPITE the severity of the global recession, consumers still have much more saving to do, if history is any guide, a new analysis says.
A report from the Bank for International Settlements (BIS) -- the organisation which represents central banks -- says the reduction in debt by households has been modest so far, even though consumer spending has fallen sharply in many advanced economies.
A study of 20 systemic banking crises that were preceded by surges in credit showed that in 17 cases, debt relative to gross domestic product (GDP) returned to levels seen before the crisis, economists Garry Tang and Christian Upper write in the BIS's latest quarterly review.
"If history is any guide, we should expect to see a much more significant reduction in private-sector debt, particularly of households, than has so far taken place after the recent crisis," they say. "Lower house prices may induce households to reduce their desired level of debt.
"Similarly, a lower level of output and tighter financial conditions could put firms under pressure to reduce their leverage."
But economies can grow, even while debt is being reduced, they say.
In most cases in the study, growth rebounded. But this depended on banks recognising losses and building up capital.
"We take this as an indication that it is possible to reduce debt and still experience healthy growth," the report says.
"For this to be the case, policy makers have first to fix the problems in the banking system that led to the financial crisis."
The smallest amount of debt reduction by private borrowers recorded in the study was in Chile, where the ratio of debt to GDP fell by 10 percentage points from 1982-1983.
Yet that is still more than the reduction seen in the current crisis, according to the report.
The study showed the ratio in the 17 nations' studies, which included Japan, Russia and Sweden, fell an average of 38 percentage points after a crisis because of defaults and repayments, inflation and economic growth.
The study is particularly relevant to Ireland, where falling GDP means the debt ratio is rising even if households take on no new borrowings. The increase in debt was also the highest among advanced economies, with lending to the private sector soaring from 60pc of GDP in 1997 to 200pc in 2008.