Meet the Author

O. Emre Ergungor |

Assistant Vice President and Economist

O. Emre Ergungor

Emre Ergungor is an assistant vice president and economist in the Research Department at the Federal Reserve Bank of Cleveland. He is responsible for the household finance section of the Banking Policy and Analysis Group, which conducts research on regulatory policy and banking issues and provides advice on financial policy formulation. He also oversees the Federal Reserve System’s Muni Financial Monitoring Team (FMT), which monitors municipal bond markets, state and local funding, and public pension funds. Dr. Ergungor specializes in research related to financial intermediation, information economics, housing policy, and credit access in low- to moderate-income households.

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Meet the Author

Kent Cherny |

Research Assistant

Kent Cherny

Kent Cherny was formerly a research assistant in the Research Department of the Federal Reserve Bank of Cleveland.


Economic Trends

Household Finances and a Sustainable Recovery

O. Emre Ergungor and Kent Cherny

Consumption accounts for roughly 70 percent of the country’s gross domestic product. Consequently, a sustainable economic recovery depends on a recovery in household consumption.

To get a handle on prospects for near-term household consumption, we consider three indicators likely to affect individuals’ propensity to consume—disposable income growth, existing debt burdens, and overall household balance sheets—within the context of historical averages taken prior to the current recession (for income) and prior to the housing boom (for debt and balance sheets). In this manner, we can examine current household financial resources relative to periods when they were not inflated by a housing-dependent economy or undergoing sharp rebalancing in a deep recession.

In thinking about household finances, the obvious primary resource available for new consumption is disposable personal income. Between 1990 to 2007, annual changes in personal income fluctuated within a range of roughly 2 percent to 8 percent, with personal consumption expenditures almost always tracking closely along. However, the recession and financial crisis in 2008 pushed both negative for the first time in over 20 years. Though they have since turned positive again, both still remain 2-3 percent below their long-run growth averages.

Household consumption spending can also be funded through debt. New individual borrowing as a percentage of GDP has been negative in recent quarters, though, meaning that on a net basis loans are either being paid off (and not renewed) or are defaulting, or a combination of the two. For a sense of historical perspective, consider that the average borrowing level from 1990 to 2000—before the loose loan underwriting environment of the 2000s set in—was about 4 percent of GDP. That current levels are so far below this trend indicates that a fundamental rebalancing of household debt burdens is taking place. Personal savings rates show that households are indeed saving more, explaining part of the aggregate loan shrinkage.

Some of the contraction in household borrowing can be explained by higher-than-average defaults on mortgages, consumer loans, and credit cards. Whether consumers are paying down existing debt through savings or banks are writing bad loans off, less aggregate debt in the financial system results in either case.

The household debt service ratio, which measures repayments as a percentage of income, has been consistently falling since the third quarter of 2008. As debt levels shrink, consumers are spending less of their disposable income on repayments related to mortgages and consumer loans. A good deal of falling payments can also likely be traced to historically low interest rates, which lower debt service requirements on new debt, refinanced debt, or debt that carries floating interest rates. Still, the debt service ratio needs to fall at least 1 percent more to reach the average levels seen from 1990 to 2000.

Finally, households are unlikely to consume at high levels if their debt liabilities are high relative to their assets. Consumers borrowed money aggressively from 2000 to 2008, pushing their debt-to-assets ratio from below 13 percent in 2000 to a peak of 22 percent in 2008. Some of that leverage has disappeared as loans have been paid down or charged off, but both the sheer amount of debt accumulated in recent years and the declining value of many household assets (namely homes) will continue putting downward pressure on consumer wealth—and therefore the propensity to consume—for potentially years to come.

What does all of this bode for a recovery of consumption, the primary driver of the U.S. economy? The data shown here point to a long road ahead for a sustainable recovery. Consumers are paying down loans or defaulting, and those looking for new consumer loans are likely to find that banks are still pulling back on lending, though individuals who can secure a loan face historically low interest rates. Given the hangover of outstanding debt and recent memories of shrinking asset values, consumers may not be motivated to ramp up their expenditures. Rather, consumption will likely recover slowly as households save more and await the return of an improved labor market and the sustainable source of funding—disposable income—that it typically provides for consumption.