So between the mid-1990s and the financial crisis, the UK experienced a very powerful financial cycle – a long build-up of credit to the private sector followed by a sharp correction that has reversed some but not most of the preceding credit growth. There were of course other important elements such as lending overseas and between banks, and some would argue lending to governments. But I want today to focus on credit to the UK private sector, particularly household credit. I want to look at what lay behind the upswing of that cycle, the marked rise of credit to GDP since 1997. This is of more than academic interest. We are back to early 2000s levels of credit  1  See Schularick and Taylor (2012). BIS central bankers’ speeches  1  and debt in the economy. We are now emerging from the post crisis period of credit contraction; in the UK credit slowly began to grow again around 2012. It is now growing at almost the same rate as the economy. So now is a good time to ask: what lay behind the very rapid expansion of credit from the mid1990s to the crisis? Should we expect – or want – credit growth to return to its pre-crisis path, growing more than twice as fast as GDP? This is an important question for the Financial Policy Committee of the Bank of England as it assesses the risks to the stability of the UK financial system – where we are in the so-called “financial cycle”?
This was especially true in the last recession for the more highly indebted households who cut spending substantially than did less indebted households. That is, the distribution of debt also matters. Similar effects were seen in other countries. And there is considerable evidence that recessions that follow debt financed housing booms are worse. The IMF estimate that for each additional 10 percentage point rise in household debt prior to the global financial crisis, the consumption loss (as a percent of pre-crisis trend) was larger by 2.6 percentage points. Other studies have come to similar conclusions.13 Conclusion Since the 1980s the UK has seen a sharp and very material increase in the credit to GDP ratio and in the stock of household debt relative to income. This was particularly pronounced in the 10 year upswing of the last financial cycle when credit grew over twice as fast as GDP. This surge in credit did not finance an economic boom. Indeed, it showed little in the conventional indicators of economic activity. It comprised in the main secured lending to households for housing, driven by house prices rising consistently faster than earnings. The rise in secured debt and the increase in house prices reflected in part structural reductions in interest rates. Many of the forces that pushed down on rates over the period are long lasting and are unlikely to be reversed. To that extent, they have probably raised the sustainable level of credit to GDP.