Contributing to the pre-crisis growth

ECRI ConferenceLending to Households

after the crisisHow should the lessons from the past

be reflected in regulation16th May 2013

Brussels

Contributing to the pre-crisis growth

• Household debt an important part of the growth story• Liquidity constraints of households decreased

• Increase in homeownership contributed to stability of income

• The economic multiplier of credit boosted economy

• Life-cycle hypothesis• If economy grows, the future income expectations are high

• If expectations high, higher value over the rest of the life cycle

• If interest rates low, increasing the discount rate on the future

• Therefore it is seemingly more sustainable to take on more credit in the short term

The run-up

• As a result, relatively high leveraged households• Not a problem if economy keeps growing, but…

• Highly leveraged households are more sensitive to…• Future income-expectations changes• Change in interest rates

• A financial shock or a crisis• causes future expectations to drop quickly• Debt service increases as a ratio of income• Both lead to lower borrowing, lower spending and lower

aggregate demand than in less leveraged households, deepening the crisis

1. Household-debt development on EU and

member-state level

No clear pattern on EU aggregate level

A range of different developments in EU member states

European “Core” – overall household debt levels in real values

Stable or rising debt levels throughout the crisis

European “Periphery” – Overall household debt levels in real values

Crisis having large effect on the household-debt growth rates

1. Household-debt development on EU and member-state level

• EU aggregate data not telling any story• Necessary to go on member-state level• What was driving such vast diversity?

• Financial market integration and innovation

• Limited policy encouragement of home-ownership

• All leading to higher supply everywhere, but…

• The cost of credit• Extremely different real interest rates (APR) across the EU

• Significant correlation with debt expansion

2. The cost of credit

Real APR across the EU – a diverse picture

2. The cost of credit

• Relative stability of real interest rates in the core• A more varied cycle in the case of periphery• Great volatility in the new member states• Sometimes persistently low interest rates during high-

inflation periods, inflating the debt• In CEE countries pegged to the euro the most radical

development during the crisis• Consumer credit spreads increasing

• Reflecting the rise in risk of income losses (no collateral)

Real APR in the core and periphery countries

3. Diverging or converging?

Relative Standard Deviation between EU member states

3. Diverging and converging

• A continuing decrease in relative mean deviation among EU27• Persistent convergence in terms of household indebtedness per capita

and to GDI since 2000

• The rate of convergence• Tended to accelerate year after year until 2004

• Was interrupted before the crisis by the indebtedness of the European periphery rising above the EU average

• Subsequently, by the financial crisis and fast debt reduction in some new member states

• The rate of convergence of CEE10 to EU15 has been significantly slowed down by the crisis.

Divergence influnced by the movement between the core and the periphery

Not as much between theEast and the West

Real APR in the old and new member states

3. Diverging or converging?

• Very little convergence between the East and the West• Some convergence between the core and the periphery

• Hopeful? Is this what we need?

• Somehow a god result in terms of what we would expect of the recovery, but…

• The most leveraged countries have the most difficulties with aggregate demand, which retrenches as households deleverage

• It can be good but depresses the economy further and renders remainders of the debt less stable and consequences of it more severe

4. Should EU households reduce their debt

What influences deleveraging

• An intuitive conclusion would be that recent debt-reduction would be associated high household leverage

• This is not the case

• The most significant determinants are the rates of credit expansion before the crisis and interest rates

• Interest rates reflecting the rising risk premia linked to income disruptions (unemployment, stagnant wages)

• This points out to a limited convergence and raises doubts on the structural homogeneity of EU member states

• In other words: high debt in some countries is more sustainable than in others even if controlled for income!

Deleveraging because of what?

ATBE

BG

CY

CZ

DEDK

EE

EL

ES

FI

FR

HU

IE

IT

LUMT

NL

PL

PT

RO

SE

SI

SK

UK

-20%

-10%

0%10

%20

%

Deb

t gro

wth

(cris

is p

erio

d, 2

009-

2012

)

0% 100% 200% 300%

Debt growth (pre-crisis period, 2003-2007)

Linear prediction plot (R²= .2675***)

ATBE

BG

CY

CZ

DEDK

EE

EL

ES

FI

FR

HU

IE

IT

LU

NL

PL

PT

RO

SE

SI

SK

UK

0% 100% 200%

Leverage to GDI at peak (December 2007)

Linear prediction plot (R²= .0024)

Source: ECRI, ECB, Eurostat; Note: *** p<0.01

Deleverage now or deleverage later

• Should households deleverage now?• There is debt overhang in some member states, but its

reduction during the recession can be more costly than leaving it alone for the moment

• The effects of household debt on demand and historic data suggest that deleveraging should occur after the recovery

• Most of the effects on household debt cannot be dealt with on the regulatory level

• The real problem not debt but weak or no recovery

• The monetary transmission mechanisms