Consumer Debt

I just took a look at last week’s release of the Fed’s Flow of Funds Report for 2003. It shows debt levels, especially among consumers, that have increased very rapidly in recent years. Much of this is due to the famous increase in mortgage debt that consumers took on last year, but other types of consumer debt also grew at a healthy clip. In all, consumer debt grew by 10.4% in 2003.

The odd thing is that such rates of increase in consumer debt are more typical of a year near the peak of the business cycle than a year near the trough. In fact, as this CBS Marketwatch story pointed out, the last time consumer debt grew this fast was back in the boom year of 1988.

I confess to being a bit puzzled. I have never really heard a satisfactory reason for why consumers have recently been willing to increase their debt at such a rapid rate when their incomes have been stagnant. Typically when the economy is slow we see consumers paying down debt, or at least acquiring it more slowly, because they (sensibly) worry about their ability to repay. But not this time.

In my opinion, low interest rates are not a sufficient explanation for the boom in consumer debt. Interest rates are almost always very low at this point in the business cycle. Real interest rates are not lower than usual right now (e.g. they are about the same as in 1993, which was arguably a similar point in the last business cycle – see this post for data). Perhaps people are being fooled by the low nominal rates, even though real interest rates are not low? Is this phenomenon all driven by money illusion? I’d like to think not, but until I hear another convincing story, that’s what I’m left with…