The Federal Reserve and Private Debt
My colleague Theodore Cangero wrote yesterday about the Federal Reserve’s role in continuously expanding government debt. The Fed’s loose monetary policy has also encouraged households and businesses to take on more private debt. In 2015, government or public debt stood at $18.8 trillion (104 percent of gross domestic product), while private debt was $27.1 trillion (150 percent of GDP). But some private debt is essential for growth, and it is dispersed among millions of households and businesses, so should we really be concerned about the amount? Many economists strongly believe so, arguing that the level and growth of a nation’s private debt, more so than public debt, predicts the worst recessions.
When the Fed keeps interest rates artificially low, as it has ever since the 2008 financial crisis, it encourages households and businesses to borrow more. Furthermore, the Austrian theory of the business cycle predicts that governments’ inflationary policies will encourage private debt that is higher than the equilibrium level by interfering with individuals’ and businesses’ economic calculations. When governments and central banks pump more money into the economy, it appears to businesses that more funds are available for production and investment, leading to over-capacity, debt, and ultimately, recessions.
Richard Vague, author of “The Next Economic Disaster,” points to a common trend among the worst recessions and depressions of the past century: private debt totaling over 150 percent of GDP, and an increase in that ratio by at least 18 percent over five years. This was true of the run-up to the Great Depression, of Japan in the 1990s, and of the 2008 crisis. Furthermore, deleveraging private debt is almost never painless. As Vague and others say, a reduction in private debt almost always comes with at least one of four events: an increase in public debt, high inflation, a trade surplus, or a recession or depression. The U.S. has not had a significant trade surplus in almost 100 years. This means the options for private deleveraging are to substitute government debt, inflate it away, or let households practice their own version of austerity.
It is not a foregone conclusion that we need to radically reduce private debt, but it is noteworthy that we are hovering around 150 percent of GDP, the risky threshold in Richard Vague’s criteria. While there may be no good alternatives to significantly reduce private debt, we can reduce the size of the problem in our future by rethinking the Fed’s inflationary monetary policy.
Max Gulker
Max Gulker is a former Senior Research Fellow at the American Institute for Economic Research. He is currently a Senior Fellow with the Reason Foundation. At AIER his research focused on two main areas: policy and technology. On the policy side, Gulker looked at how issues like poverty and access to education can be addressed with voluntary, decentralized approaches that don’t interfere with free markets. On technology, Gulker was interested in emerging fields like blockchain and cryptocurrencies, competitive issues raised by tech giants such as Facebook and Google, and the sharing economy.
Gulker frequently appears at conferences, on podcasts, and on television. Gulker holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxg_econ.
