Will squeezed households really borrow more to prop up living standards?

Office for Budget Responsibility is challenged over the question of personal debt.

What are we to make of different views on the extent to which growing household debt will offset the squeeze in living standards in the coming years?

The independent Office for Budget Responsibility caused a bit of a stir at the time of the Budget when it suggested that household debt is set to rise over the rest of the parliament – from £1.6trn in 2011 to £2.1trn in 2015, or from 160 per cent of household disposable income to 175 per cent. Rising debt will sit alongside low savings, so the ratio of household saving to disposable income will fall to roughly 3.5 per cent – half its average over the past 50 years – for the duration of the OBR's forecast period.

The clash between these projections and the government's favoured narrative concerning the need for the country to rein in its debt-fuelled spending habits – public and private – attracted some attention and prompted an online debate about whether tighter fiscal policy is shifting the balance between public and private debt.

However, the underlying economic implications, and their impact on household living standards between now and the next election, remain largely unprobed. Last week the OBR published a little-noticed note that set out to clarify why it has changed its projections for household debt since last June. It makes for interesting reading – but doesn't really answer the most fundamental questions.

The most important argument that the OBR makes is that – regardless of high existing levels of debt – household indebtedness will continue to rise over the next four years as families battle to sustain their living standard, running down savings and ratcheting up more borrowing. And it is worth noting that the OBR explicitly says that its projection for household debt is premised on steadily easing credit conditions and a stronger housing market.

The savings ratio

The critical question is whether the OBR is right about how households will react: is a further rise in personal indebtedness, already at historically unprecedented levels, a realistic account of how households at the sharp end of the living standards squeeze will behave over the medium term in the post-crunch economy?

No one really knows. We can't. Never in modern times have we seen the combination of such a large fall in household incomes, the severity of the shock to the credit system, and plummeting consumer confidence. So it is very hard to know what the OBR bases its behavioural assumptions on when it claims that greater debt will prevent falling disposable incomes feeding through into reduced expenditures.

It's a view that seems to run counter to a range of recent expert opinions and forecasts. For example, the Council of Mortgage Lenders has referred to the OBR projection on the scale of the increase in household debt this year as "wildly optimistic" and at odds with its own forecasts, while PwC has projected household debt to be falling as a proportion of GDP throughout this parliament.

Roger Bootle of Deloitte has just marked down consumer spending growth in 2011 to -1 per cent, and takes issue with the notion that household savings will fall further in the medium term, saying that tight credit conditions and the current weakness of consumer sentiment will "surely mean that households will want to save more, rather than less". Likewise, the NIESR, in its most recent quarterly update, predicts that following a short-term reduction this year, the savings ratio will rise steadily until 2015.

Analysts in the US are similarly sceptical about the scope for medium-term falls in their savings ratio: Cardiff Garcia has argued in the Financial Times that, while such a position might boost the economy in the short term, "nobody would think it healthy" for the savings rate to return to the "absurd" levels of the mid-Noughties.

Room for manoeuvre?

So much for the forecasters and pundits; what does the public say? Despite a well-documented shift from borrowing to saving since the start of the credit crunch, UK households remain severely debt-stressed. Bank of England polling data shows that, at the end of 2010, half of all households said they were concerned by their level of debt.

Borrowing more remains off limits for many: one-third reported suffering some form of credit constraint. At the same time, one in three households reported savings of under £500 – leaving little scope for protecting living standards by dipping into these funds.

Our own analysis at the Resolution Foundation shows that those on low to middle incomes face sharper constraints than better-off households. As the chart below shows, while around one-third (31 per cent) of households in the top half of the income distribution said they were finding it harder to borrow to finance spending in 2010 than in 2009, this rose among those on low to middle incomes to over half (53 per cent), up from just 16 per cent in 2007.

And these are exactly the people who are going to feel the fall in living standards most acutely and who, presumably, the OBR expects to borrow more. Looking to the future, one-fifth of all households said they were saving more in anticipation of fiscal tightening. Just 3 per cent were planning on spending more.

Taken together, these findings provide powerful grounds for asking what would happen if the OBR used different assumptions about how households may run down, as well as build up, debt during the prolonged fall in living standards. Without this, existing projections appear to be a bit of a punt.

No doubt setting out different scenarios for debt in this way would expose some uncomfortable findings: growth is bound to be weaker if household expenditure tracks falling disposable income more tightly than the OBR currently expects. Projections for net exports and business investment can't just be pumped up to take up the slack. But that isn't a reason to avoid the issue.

Despite all the frothy rhetoric about "rebalancing of the economy", the growth of household consumption will be absolutely pivotal in the resumption of steady growth. Indeed, the key factor determining the strength of the UK recovery will be the uncertain reactions of millions of households, which are already close to the edge, to further falls in disposable income. The question of whether ever more personal debt can be used to fill the growing gap in living standards deserves far more serious scrutiny than it has received to date.

Gavin Kelly is chief executive and Matthew Whittaker senior economist, both at the Resolution Foundation.

This post originally appeared on the Resolution Foundation blog.

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The Telegraph’s bizarre list of 100 reasons to be happy about Brexit

“Old-fashioned light bulbs”, “crooked cucumbers”, and “new vocabulary”.

As the economy teeters on the verge of oblivion, and the Prime Minister grapples with steering the UK around a black hole of political turmoil, the Telegraph is making the best of a bad situation.

The paper has posted a video labelled “100 reasons to embrace Brexit”. Obviously the precise number is “zero”, but that didn’t stop it filling the blanks with some rather bizarre reasons, floating before the viewer to an inevitable Jerusalem soundtrack:

Cheap tennis balls

At last. Tennis balls are no longer reserved for the gilded eurocrat elite.

Keep paper licences

I can’t trust it unless I can get it wet so it disintegrates, or I can throw it in the bin by mistake, or lose it when I’m clearing out my filing cabinet. It’s only authentic that way.

New hangover cures

What?

Stronger vacuums

An end to the miserable years of desperately trying to hoover up dust by inhaling close to the carpet.

Old-fashioned light bulbs

I like my electricals filled with mercury and coated in lead paint, ideally.

No more EU elections

Because the democratic aspect of the European Union was something we never obsessed over in the run-up to the referendum.

End working time directive

At last, I don’t even have to go to the trouble of opting out of over-working! I will automatically be exploited!

Drop green targets

Most people don’t have time to worry about the future of our planet. Some don’t even know where their next tennis ball will come from.

No more wind farms

Renewable energy sources, infrastructure and investment – what a bore.

Blue passports

I like my personal identification how I like my rinse.

UK passport lane

Oh good, an unadulterated queue of British tourists. Just mind the vomit, beer spillage and flakes of sunburnt skin while you wait.

No fridge red tape

Free the fridge!

Pounds and ounces

Units of measurement are definitely top of voters’ priorities. Way above the economy, health service, and even a smidgen higher than equality of tennis ball access.

Straight bananas

Wait, what kind of bananas do Brexiteers want? Didn’t they want to protect bendy ones? Either way, this is as persistent a myth as the slapstick banana skin trope.

Crooked cucumbers

I don’t understand.

Small kiwi fruits

Fair enough. They were getting a bit above their station, weren’t they.

No EU flags in UK

They are a disgusting colour and design. An eyesore everywhere you look…in the uh zero places that fly them here.

Kent champagne

To celebrate Ukip cleaning up the east coast, right?

No olive oil bans

Finally, we can put our reliable, Mediterranean weather and multiple olive groves to proper use.

No clinical trials red tape

What is there to regulate?

No Turkey EU worries

True, we don’t have to worry. Because there is NO WAY AND NEVER WAS.

No kettle restrictions

Free the kettle! All kitchen appliances’ lives matter!

Less EU X-factor

What is this?

Ditto with BGT

I really don’t get this.

New vocabulary

Mainly racist slurs, right?

Keep our UN seat

Until that in/out UN referendum, of course.

No EU human rights laws

Yeah, got a bit fed up with my human rights tbh.

Herbal remedy boost

At last, a chance to be treated with medicine that doesn’t work.

Others will follow [picture of dominos]

Hooray! The economic collapse of countries surrounding us upon whose trade and labour we rely, one by one!

Better English team

Ah, because we can replace them with more qualified players under an Australian-style points-based system, you mean?

High-powered hairdryers

An end to the miserable years of desperately trying to dry my hair by yawning on it.

She would’ve wanted it [picture of Margaret Thatcher]

Well, I’m convinced.

I'm a mole, innit.