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13 April 2022

Why household debt is surging and what that means for the economy

With wages failing to keep up with soaring prices, households are turning to short-term borrowing, which increases the risk of recession.

By James Meadway

Household debt in the UK is rising at its fastest rate since Covid-19 arrived two years ago, with credit card borrowing in February reaching the highest level since records began. The reason for this is not hard to guess: even before Russia invaded Ukraine, prices (especially of essentials) were spiralling upwards, well ahead of pay rises. Households are resorting to short-term borrowing to make good the difference.  

Inflation is only expected to increase over the next few months, as the supply chain disruptions, extreme weather and, of course, the monumental disruption of the war in Ukraine play out in global markets. Should heavily indebted households be forced to spend more and more servicing their rising debts, and cutting back even further on spending outside of essential items, the drag on the economy will intensify. Spending on debt interest and repayments sucks money out of the whole economy. Spending on food that is mostly imported, or gas and oil from abroad, does little for the British economy specifically. 

Global food prices, in particular, are already at all-time highs, as registered by the Food and Agriculture Organisation’s (FAO’s) monthly food price index. Russia is the world’s largest wheat exporter, and Ukraine is in the top five. Together they account for more than a quarter of the grain’s global exports. The invasion and sanctions have dramatically restricted harvests and sales, driving prices up 17.1 per cent since the war began in February. A severe drought in Iran last year had already squeezed production and global stocks, although relative to the last global wheat supply crisis in 2008-09, stocks across the world still remain high. Both Russia and Ukraine, meanwhile, are also major suppliers of maize, barley and edible oils, all of which have seen similar price surges since the start of the year, and Russia is the world’s largest exporter of fertilisers – an essential input in food production, shortages of which are already forecast to affect harvests throughout this year. 

As a result, disruptions to global food supplies are expected to continue, even if the war is somehow speedily resolved. For lower-income countries, and especially those wracked by conflict, this means there is a serious risk of outright famine this year. The FAO has warned that acute food insecurity is likely to deteriorate in 20 more countries over the next few months, with Yemen and Afghanistan among the worst hit. The impact is less severe in the developed world, but remains dreadful, highlighting the extremes of inequality in the richest countries on the planet. More than half of parents in the UK that responded to a Food Foundation survey reported being worried about their children’s health and wellbeing because they were unable to afford food or energy bills.  

Many are turning to debt to plug the gap. But higher household debt increases the vulnerability not only of the affected households but of the entire economy to future economic disruption. Countries entering the 2008 financial crisis with higher levels of household debt appear to have suffered more severely, as heavily indebted households pulled back on their spending more rapidly, amplifying the initial financial shock to the economy. In a world as unstable as ours, not only are future prospects for growth worsening as a result of rising debts today, but the risks of severe recession from likely future shocks – whether that is extreme weather, further disease outbreaks or financial crises erupting elsewhere in the world – are increasing. 

While rising household debt used to help fuel wider economic growth, pushing whole economies along, it is now turning into a significant drag. What the economic sociologist Colin Crouch called “privatised Keynesianism” before the crash of 2008 saw households taking on more debt to sustain (and even increase) their own consumption, even as wage growth fell behind.

Sustaining a situation of continually rising debts relative to incomes required households to be able to continually roll over their debt at low levels of interest. But unlike governments attempting the same trick, households lacked both tax-raising powers and the ability to legally issue their own currency. Once debts couldn’t be rolled over as house prices peaked, the bubble burst: starting in the US, and then spreading rapidly throughout the developed world. Household borrowing since, especially during the pandemic, has been skewed away from “discretionary” spending – on non-essentials items such as new cars or TVs – and increasingly into essentials like housing, food and energy bills. Retail sales have been falling even as household debt has been picking up.

As inflation will continue to rise over the next few months, with the Bank of England expecting it to peak at 8 per cent, the squeeze on household finances and risks to the economy will increase too. The Resolution Foundation is already forecasting 1.3 million falling into absolute poverty in Britain. But even those slightly better off will feel the worst squeeze on their living standards for generations, and may have to cut back on spending to cope, risking a recession. This is happening even as profits have recovered strongly, which should not be surprising: if prices are rising, but household incomes are not, someone, somewhere will be collecting the difference.

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Tragically, neither main party in the UK seems to grasp the scale of the crisis that is bearing down on people. The millionaire Chancellor, Rishi Sunak, has offered a £200 loan to households facing £700 energy bill increases, with £150 off council tax for some, while Labour’s grand plan is to give them “up to” £600.

The cost-of-living crisis is fundamentally one of prices being too high and pay too low – now joined by rising debts. To tackle it immediately, either party would have to step well outside of its comfort zone and start getting serious about redistributing incomes and wealth. Three redistributions are needed: from creditors back to debtors, by writing off unpayable debts; from monopolists charging excessive prices, through stricter controls on price rises; and from profits in general back to wages and salaries, with inflation-busting pay rises – including a double-digit increase in the national living wage.

[See also: Why the OBR’s bleak economic forecasts are not bleak enough]

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