The market value of households’ financial and housing assets has fallen by over 10% over the past two years. Does this mean that there is some form of hole in households’ balance sheets that will weigh on the recovery as they seek to repair it? 2  This increase reflects purchases of assets. It does not include the returns from these investments. BIS Review 114/2009  3  Any real or perceived need for households to rebuild their balance sheets may play an active role in determining their levels of spending. 3 For example, the cost of financing debt and the uncertainty about future employment prospects may make households reluctant to exceed a certain level of net borrowing. In this case, the deterioration in the financial position of some households may cause them to spend less in order to repay debt or increase savings. The “payback period” I mentioned earlier. This possibility has focussed much recent attention on the state of households’ balance sheets. But standard measures of households’ financial position – such as the ratio of debt to assets – may exaggerate the severity of the problem. That is because these conventional measures suffer from a “missing” asset and a “missing” liability. Let me explain. The “missing” liability is the cost of purchasing a house in the future. This argument is directly related to the redistribution argument I discussed earlier.
A natural place to start would be with the “consumption boom”, which is often presumed to have preceded the bust. But in fact there was no such boom. Between the turn of this century and the onset of the financial crisis, consumer spending increased no faster than it had done, on average, over the past 40 years. 1 Moreover, the fraction of our national output consumed by households did not increase. The kernel of truth in the consumption boom story is that changes in the distribution of our national income meant that this stable growth of aggregate consumer spending was associated with a sharp decline in the household savings ratio. The proportion of income that households set aside fell from close to 10% in 1997 to a little over 2% ten years later. Although there was no spending boom, households were making less provision for the future. Where did all the debt go? But how does the absence of a spending boom fit with the headlines about the rise in debt. The big increase in household debt over the past decade is certainly not a myth. Household  1  Consumption growth was, however, unusually strong in the period 1996-2000. My colleague Andrew Sentance has stressed the importance of analysing trends in consumption over longer periods (eg Sentance 2007). 2  BIS Review 114/2009  debt as a proportion of income increased from 100% to 165% in the 10 years to 2007.