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How Much Debt Is Too Much?

LONDON – Is there a “safe” debt/income ratio for households or debt/GDP ratio for governments? In both cases, the answer is yes. And in both cases, it is impossible to say exactly what that ratio is. Nonetheless, this has become the most urgent macroeconomic question of the moment, owing not just to spiraling household and government debt since 2000, but also – and more important – to the excess concern that government debt is now eliciting.

According to a 2015 report by the McKinsey Global Institute, household debt in many advanced countries doubled, to more than 200% of income, between 2000 and 2007. Since then, households in the countries hardest hit in the 2008-2009 economic crisis have deleveraged somewhat, but the household debt ratio in most advanced countries has continued to grow.

The big upsurge in government debt followed the 2008-2009 collapse. For example, British government debt rose from just over 40% of GDP in 2007 to 92% today. Persistent efforts by heavily indebted governments to eliminate their deficits have caused debt ratios to rise, by shrinking GDP, as in Greece, or by delaying recovery, as in the UK.

Before modern finance made it easy to live on borrowed money, getting into debt was considered immoral. “Neither a borrower nor a lender be,” Shakespeare’s Polonius admonishes his son Laertes. The expectation of uninterrupted economic growth brought a new perspective. Mortgage debt, unknown a century ago, now accounts for 74% of household debt in developed countries (43% in developing ones). Banks have been lending, and households borrowing, as if tomorrow was sure to be better than today.