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Debt Debate

The Federal Reserve Bank of Kansas City released a new economic study yesterday that says the rising consumer debt burden may not foreshadow an economic slowdown. The report says it is complicated to get a reliable measure of consumer debt since card debt data is skewed by consumers charging routine bills or the rise in card use for business expenses. The study also cites the fact that more credit cards are being issued to lower income households as another factor making debt burden numbers unreliable indicators.

Some analysts and business leaders think recent increases in the consumer debt burden, relative to consumers’ ability to repay, may foreshadow an economic slowdown. But a new economic study by the Federal Reserve Bank of Kansas City shows that other factors need to be considered before any alarm is sounded.

C. Alan Garner, an assistant vice president and economist, explores the link between the debt burden and consumer spending in the current issue of the Kansas City Fed’s Economic Review.

In his article, “Can Measures of the Consumer Debt Burden Reliably Predict an Economic Slowdown?” Garner first explains how consumer debt may affect economic activity, then describes alternative measures of the debt burden, presents empirical evidence showing these measures have not been highly reliable for predicting economic growth in the past, and argues that recent changes in the financial system have added to the uncertainty about how to interpret a rising consumer debt burden.

“Monitoring consumer debt is complicated because there are several ways to measure the debt burden,” Garner writes, citing such variables as the dollar amount of consumer debt, debt service payments, payment delinquency rates and the number of personal bankruptcies.

Complicating the issue further, Garner says, “Recent changes in the financial system have made it more difficult to interpret the rise in consumer debt over the last few years.”

He notes that some of those changes, like aggressive promotions by credit card issuers and the fact that more credit is being extended to lower income households, may make the debt burden a more reliable indicator of future economic activity.

Other changes, such as using credit cards for routine bills or for home- based business expenses, may make the measures less reliable since these practices add to the amount of consumer debt outstanding, but don’t necessarily indicate a rising repayment problem. Similarly, home equity loans and auto leasing fail to show up in consumer debt statistics, but both are long-term commitments that could increase chances of financial distress.

“The current increase in the consumer debt burden must be interpreted in the context of a generally healthy economic situation for U.S. households,” Garner points out. He cites solid gains in employment and disposable income, along with a relatively high saving rate, to suggest spending could grow even faster than income.

“In addition,” he concludes, “household wealth has been rising because of higher stock prices, and consumer confidence has remained at high levels. Viewed in this generally favorable context, the rise in the consumer debt burden does not appear alarming.”

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