CURRENT ISSUE The Burden of Debt ecent news reports on the current condition of U.S. consumers have been disturbing. Aggregate data show that consumer debt levels and debt service burdens have trended upward in recent years. Some economic analysts believe that a large consumer debt burden presents a notable risk to the economy as it struggles through a transition to a more sustainable growth rate. They are quick to point out that high debt levels and related debt service payments may spur a retrenchment of consumer spending. Are concerns warranted? Consumer debt statistics, put in perspective, can be used for drawing inferences about how well consumers are positioned in terms of servicing their debt levels. In this regard, debt service payments must be examined relative to income flows in order to get a sense of how sustainable debt levels are. The “why” of consumer debt But debt also has potential drawbacks. Other things being equal, when consumer debt levels are high there is a greater risk that some debt cannot be serviced; that risk carries with it the costs related to default or bankruptcy. High debt burdens also raise the possibility that consumers could rein in their future spending to a considerable degree. These risks become even higher, for a given debt level, when the economy slows and sustained income growth is uncertain. What the data say The 1998 Survey of Consumer Finances shows that nearly 20 percent of families earning a gross income of less than $50,000 per year had more than 40 percent of their income earmarked to cover debt payments. These consumers could be the first to suffer if the labor market should soften considerably, pushing them to dramatically curtail their consumption and possibly default on loans. What to watch for But what might the future hold? In one upbeat scenario, households will adapt quickly to slower economic growth and rearrange their finances to prevent financial dislocations. In response, consumer debt burdens should level off and then recede over time, preventing widespread financial distress and consumer retrenchment. Still, any transition involves uncertainty with respect to the economic outlook. The performance of economic fundamentals, mainly employment and income growth, will be of primary importance to low- to middle-income families in particular as well as to the well-being of the overall economy. By Ellis Tallman, assistant vice president of macroeconomic research |