Need or want: what explains the run-up in consumer debt?

Author:Weller, Christian E.

The past few years have been marked by a record run-up in consumer debt. Total household debt grew more than four times faster between March 2001 and the middle of 2006 than it did in the 1990s.

This rise in consumer debt occurred against the backdrop of a number of important macro trends. After the previous business cycle ended in March 2001, families saw the weakest employment growth since the Great Depression, stagnant wages, and declining health and pension benefits. At the same time, costs for housing, a college education, health care, and transportation rose sharply. To bridge the growing gap between income and costs, families borrowed heavily, sending consumer debt to record highs.

This debt surge was widely shared across demographic groups. In fact, it was more pronounced among middle-income and white families than among their counterparts. Consumer credit became an equalizer of financial insecurity.

The data suggest that the run-up in debt is more a consequence of economic necessities than of profligate spending. While the desire for instant gratification is probably a small contributing factor, it is far outweighed by the need of families to borrow more amid sluggish income growth and rising prices. In fact, families have become more willing to be financially responsible over time. Further, it is argued that families borrowed to invest, especially in real estate. The data, though, suggest that families did not see a markedly sharper rise in their wealth in recent years than in previous years when debt growth was more subdued. In addition, much of the wealth gains that families saw were due to a boom in the real estate market, which many economists believe to be overvalued.


The debt boom of the past few years occurred against .the back drop of a weak labor market and rapidly rising prices for important consumer items. Real family incomes did not rise in any single year between 2000 and 2004, before recovering a little in 2005, but median family incomes were still below those in 2001 (U.S. Bureau of the Census (Census) 2006). The earnings for men and women who worked full-time all year declined again in 2005, to their lowest level since 1997 for men, and since 2000 for women (Census 2006). Almost all groups saw either declines or flat incomes during this period. From 2000 to 2005, real incomes of black families declined by 8.2%, those of Hispanic families by 4.3%, and of white families by 2.5%. Low-income families' incomes declined by 7.5% compared to a decrease of 3.3% for middle income families (Census 2006).

Simultaneously, prices rose sharply. Health care costs shot up the fastest, but other costs also grew. Food, housing, and household operations all saw average quarterly price increases of 2-3% between 1990 and 2006. In comparison, expenditures on smaller consumption items grew at about half that rate (Weller and Staub 2006).

To manage rising prices and stagnant and declining income, families borrowed more. By June 2006, families had amassed debt equivalent to 129.3 percent of disposable income after rising on average 1.3 percentage points per quarter from March 2001 through March 2006. In comparison, from December 1995 through March 2001 it grew by an average of 0.4 percentage points, four times slower. Simultaneously, the share of disposable income used to pay off debt reached a record high of 14.4% in June 2006 (Board of Governors of the Federal Reserve System (BOG), 2006).

Using survey data from the Survey of Consumer Finances (SCF), trends in household debt by demographic characteristics are discernible (see Weller 2006). The survey data show that all families saw sharp increases in the amount of debt they owed relative to their total income. However, middle income families and white families saw larger increases in their debt to income ratios than for their counterparts (Table 1).

This pattern of debt growth relative to income shows differing combinations of the need to borrow and access to credit. The comparatively lower growth of debt to income for low income families, for example, couples the need to borrow with limited access to credit. Low income families are disproportionately renters and thus cannot offer their home as collateral. They have also seen less income growth than their counterparts, which raises their need to borrow faster than for other families, but gives them less collateral to borrow against. For high income families, credit access is less limited since...

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