UK Consumer Debt: A cause for alarm?

As consumer debt in the UK reaches pre-2008 financial crisis levels within a new low interest rate austerity dynamic, we examine whether there is reasonable cause for concern and how the Government and Bank of England mitigate the risk.

Consumer debt is an individual form of debt which is composed primarily of credit card, household, and car leasing expenditure. Mortgages and student loans are not included as they are generally seen as investments. Consumer debt is not productive, it is simply for consumption. In moderation, consumer debt is encouraged as it increases spending into the economy and incites growth. When debt levels climb at a constant pace, growth can continue to flourish. However, as soon as the market is spooked and business falters or unemployment rises, widespread debt can easily escalate a small treatable market blip.

Before the 2008 financial crisis, the Bank of England’s data on consumer debt in the UK was recorded at £2.08 trillion. As the crisis spread and markets were in turmoil, the first 4 months saw £200 billion of credit vanish. With the continuous real wage rate decline and rise in unemployment, total consumer debt dropped to £1.5 trillion in 2012.

In January 2018, the UK’s consumer debt has reached pre-crisis levels and, as of April 2018, stands at £2.1 trillion. Although the figure matches pre-crisis levels, the reasons for the build-up are largely different.

To remediate the effects of the crisis and recession, the Bank of England, among other stimulus packages, lowered interest rates to encourage spending and investment – which in turn would fuel growth. Individual borrowers saw this as a great opportunity to get their hands on ‘cheap’ money. Independently, the Bank of England’s interest rate policy follows sound economic theory, however, the Government took a contrasting approach which has led to this unique situation.

Austerity vs Stimulus Dynamic

The Bank of England’s technocratic approach was semi-countered by Government’s ideologically-driven austerity plan. On the individual level, a problematic scenario emerges: Cheap debt and tight Government fiscal policy. In the UK, figures from February 2018 show that 44.8% of the population are either financially struggling (low income, benefit dependent, social housed, median savings of £50) or squeezed (low income, private renters, one shock away from problems, median savings of £580). These people, whose financial situations are worsened by tight fiscal policy, are given a lifeline from the artificially low interest rates – leaving some core issues unresolved and a mountain of debt rising. The higher consumer debt piles up the more damaging potential it has. As the boom and bust cycle of economics will indefinitely continue, solving fundamental consumer debt behaviour can lessen the impact

Mitigation Efforts

The Bank of England’s interest rate is managed in a fashion that allows markets to predict rate changes to reduce unnecessary market fluctuations. A rise of bank interest rates will have the effect of slowing a debt build-up, as borrowing money will become more expensive. This idea has already been floated by Monetary Policy Committee member Gertjan Vlieghe specifically in response to ever-rising consumer debt. The UK Government’s austerity plan will eventually end with a fiscal loosening that can be an effective tool countering any economic blips.

On a societal level, the topic of indebtedness has increased its salience. A recent cross-party effort led by MP George Freeman and MP Liam Byrne demonstrates the presence of political will to tackle this epidemic. The wider social cost of consumer debt is estimated to be £8.3 billion. Badly managed debt, as a social problem, must be tackled on a societal level. The MP’s campaign could help encourage a more responsible approach to debt.

Is it really that bad?

Research by staff at the Bank of England and the Financial Conduct Authority recently suggest that the rise in total consumer debt is actually attributed to an increase in safe borrowers taking on more debt. Those with above average incomes are likely to have good credit ratings and opportunities to leverage higher.

The Brexit referendum result and the depreciation of the sterling currency did not lead to disaster for the UK economy. The organised timeline given in the negotiation stages of the Brexit process allows time for the markets to create solutions to whichever direction the negotiations go. It is unlikely there will be an outcome drastic enough to jolt markets and plunge the UK into a recession. In the unlikely event that no deal is made with the EU and UK prospects dwindle, the Government and the Bank of England will certainly use their vast resources and experience to maintain a level of stability.

To effectively control the rise of consumer debt, a lead at the societal level to promote reasonable behaviour and control towards consumer debt should be encouraged. The Government, as always, should have contingency plans for shocks to the market but it will do well in taming the epidemic levels of debt not just for the next shock, but indefinitely,  through the boom and bust cycles we will continue to experience.

This article was first published on Global Risk Insights, and was written by Fabian Bak.