The Levy Economics Institute of Bard College Strategic Analysis January 2009 Flow of Funds Figures Show the Largest Drop in Household Borrowing in the Last 40 Years Figure Change in Debt Outstanding 12 Percent of GDP 10 For further details on our latest projections, see Wynne Godley, Dimitri B. Papadimitriou, and Gennaro Zezza, Prospects for the U.S. and the World: A Crisis That Conventional Remedies Cannot Resolve, Levy Institute Strategic Analysis, December 2008. -2 08 20 04 06 20 20 02 00 20 20 98 96 19 19 92 90 94 19 19 19 86 84 82 88 19 19 19 19 80 78 19 19 74 72 76 19 19 19 70 68 19 19 66 64 19 19 60 19 19 62 -4 Households Nonfinancial business Figure Household Debt Outstanding 110 Percent of GDP 100 90 80 70 60 50 40 30 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 2000 2002 2004 2006 2008 2010 2012 08 20 04 Figure Unemployment Rate 06 20 Debt outstanding Mortgage debt outstanding 20 02 00 20 20 98 96 19 19 94 19 92 90 19 19 88 19 86 19 82 84 19 19 80 78 19 19 76 19 72 74 19 19 70 68 19 19 66 62 64 19 19 19 60 20 19 Federal Reserve Flow of Funds figures released on December 11 report a drop in borrowing that is steeper than our previous projections in April 2008. After slowing to 0.5 percent of GDP in the second quarter of 2008, the change in household debt outstanding in the third quarter was a negative 0.8 percent of GDP (Figure 1). Borrowing by nonfinancial business was still positive, although the change in this sector’s outstanding debt slowed to 2.2 percent of GDP, down from 4.2 percent in the second quarter. As Figure shows, the previous two recessions saw a marked fall-off in business borrowing—with minor consequences for households—while the current recession’s drop in credit is having a greater effect on households’ finances. As expected, a steep drop in mortgage debt accounts for most of the decline in household borrowing: the change in household mortgages outstanding is a negative 1.8 percent of GDP. Consumer credit growth, on the other hand, has slowed, but it is still a positive 2.3 percent of GDP. Sharply lower household borrowing has brought about a reversal of the upward trend in household debt (Figure 2), which nevertheless remains very large relative to income. If households’ consumption behavior has shifted toward bringing debt back to a more sustainable path, we can expect a further decline in borrowing in the coming quarters. According to the Levy Institute’s macro model, a fall in borrowing has an immediate effect—which in this case accounts for a large part of the percent drop in private expenditure that occurred in the third quarter. But it will also have delayed effects in the following quarters. As a result, the continuing decline in real GDP and accompanying rise in unemployment may be substantial (Figure 3). . Flow of Funds Figures Show the Largest Drop in Household Borrowing in the Last 40 Years Federal Reserve Flow of Funds figures released on December 11 report a drop in borrowing. on households’ finances. As expected, a steep drop in mortgage debt accounts for most of the decline in household borrowing: the change in household mortgages outstanding is a negative 1.8 percent of GDP.Consumer credit. in April 2008. After slowing to 0.5 percent of GDP in the second quarter of 2008, the change in household debt outstanding in the third quarter was a negative 0.8 percent of GDP (Figure 1). Borrowing