When Household Debt Levels Rise, Will Interest Rates Go Up?

Consumer spending has been robust throughout 2019 and is likely to continue into 2022

Despite a recent Conference Board report that said consumer confidence was down nine points in September. However, as household debt continues to rise, there is a greater risk of unforeseen financial risks, including the possibility of sharply increased interest rates. The Federal Reserve is poised to raise interest rates slowly, and a rising balance is a growing concern.

When household debt levels rise, the financial sector should respond by increasing interest rates to lower borrowing costs. High-interest rates, coupled with low savings levels, would encourage an economic expansion. Meanwhile, falling house prices and a corresponding increase in unemployment caused many households to reduce their savings, despite the “wealth effect.” A decrease in household income made mortgage payments even harder to pay. The credit-demand model is a typical response to rising household debt in both cases.

While a rising household debt level should increase interest rates, the opposite is often. When interest rates fall, household spending should rise, boosting the economy and improving the economy. The rise in household debt increases the need for imported goods, increasing external debt. The increase in consumer debt is suitable for the housing market as it boosts the demand for these goods and services. But when interest rates go up, so does the cost of borrowing.

One study found that increasing household debt was linked to a weakening of the economy.

In addition to higher interest rates, the researchers also found a stronger relationship between the number of households with high debt and the rate at which the interest rates had fallen. After these corrections, the real growth rate of consumer debt has slowed significantly, and the number of mortgages is still significantly below the peak recorded in 2008. The rise in consumer debt is a long-term upward trend. But it is essential to keep in mind that low household incomes were the cause of the recent housing crisis, and a higher level of household delinquency is often a sign of an economic downturn.

In addition to higher household debt, low-income households face more significant risks of experiencing a downturn. Having high household debt can exacerbate these risks. The study authors point out that the more a family is indebted, the higher the downturn risk. For this reason, they stress that households should not make such high-interest purchases. It would be better to pay off the loans before taking the plunge when this happens.

In the past century, households relied on debt to finance their lifestyles. These loans tended to come with unique financial risks. For example, a home may lose a significant source of income, or it could experience sharply higher interest rates. Moreover, the risk of bankruptcy can be higher when the repayments of the debt are due to a disaster. The risk of a financial crisis is increased if a debt is not paid off in time.

The rise in household debt was the most prominent in the United States in 2010. In addition, household debt levels rose by the highest percentage since 1980, fueled by more robust economic growth and rising prices. Despite these risks, the recession was not as severe as in 2007, and there was little risk of a downturn in the same year. A recession occurs when households have too much debt, and the impact of the housing bubble can be felt in the future.

Despite these concerns, this research shows that the increasing household debt levels affect the economy. A high level of household debt results in a more prolonged recession because households with high debt levels cut back more than other households. As a result, household debt is a hazard and creates vulnerabilities. Moreover, it impairs smooth spending and investment, leading to a slowdown in global economic growth.

[ See also: Wikipedia. – Federal Reserve Board of Governors ]