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LEADING FACTORS OF HOUSEHOLD DEBT
Khairunnisa Abd Samadi, Nuradli Ridzwan Shah Bin Mohd Daliii & Siti Nurazira Mohd Daudiii
i (Corresponding author). Faculty of Business Management, Universiti Teknologi MARA Cawangan Melaka. [email protected]
ii Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia
iii School of Economics, Finance and Banking, Universiti Utara Malaysia
Abstract
The present study explores the factors of household debt. The review of previous studies show the income, working population, unemployment rate, inflation, house price, and interest rate lending are leading factors of household debt. The study therefore urges policymakers, the authority, and financial institutions to employ careful macro prudential tools that can control the identified causes of household debt increment to lessen their effect in dampening economic growth.
Keywords: Household debt, life cycle model, permanent income hypothesis
INTRODUCTION
Household debt has been historically high in many countries. The financial crisis in 2008 has served as a warning towards the detrimental effect of rapidly-increasing household debt. Advanced economies such as Switzerland, Canada, Australia and others have recorded a marked increase of household debt relative to disposable income, showing more than 15 percentage points of GDP from end 2007 to 2015 (IMF, 2017). Accordingly, the rise was also sizeable in emerging economies in which the GDP ratio to household debt was amplified by more than 30 percentage points in Malaysia and Thailand between 2007 to 2015 (IMF, 2017). The per capita credit to the household among OECD countries grew at an average annual pace of 11.2% between 1980 and 2012 (Mian, Sufi, & Verner, 2015). The increasing trends of household debt somehow expose a risk to financial crises, and most studies have revealed consistent findings (IMF, 2017; Mian and Sufi, 2009). Though household debt is certainly vital to maintain financial health, the economic growth of a country is at risk with the rapid increase in household debt (Hunt, 2015). This tremendous progression of household debt thus sparks the question: why do people accumulate debt? Hence, the present study is therefore geared to identify the factors which influence household debt.
975 THEORITHICAL FRAMEWORK
Several studies have attempted to understand the factors determining the household debt growth. Among the prominent scholars in the field, Fisher (1930) provided evidence of the great effect of consumption on household debt. According to Fisher, insufficient earning to finance consumption causes households to borrow. A leading explanation of why some households may borrow to finance consumer expenditure comes from the life cycle hypothesis (LCH) (Modigliani & Brumberg, 1954), which states that households may, during their earlier years, have a desired or required level of consumption which exceeds their current income. This gap can be financed by consumer borrowing to be repaid out of future income as grounded in Friedman’s (1957) permanent income hypothesis (PIH). PIH argues that individuals are driven to make consumption decisions based on their projected earnings prospect rather than their current earning, especially when it is minimal. Accordingly, Ando and Modigliani’s (1963) LCH, which is the evolution of the earlier LCH, contends that individuals save at an early age, accumulate wealth during the middle age, and dis- save at retirement days. Households accumulate wealth, particularly owning assets for investment; thus, debt becomes important to finance the budget constraint for wealth as well. LCH and PIH consider debt as an apparatus for a person’s stable life cycle consumption and highlight that households make a loan when earnings are lower than expected. Here, household debt can be explained through consumption and income.
Aggregate debt holdings are then given by:
(1)
In this setting, the present study is grounded on LCH and PIH as a theoretical basis (see Ando & Modigliani, 1963; Friedman, 1957). Nevertheless, limited studies have suggested the appropriate function of household debt. Some researchers have challenged that it has limitations. The model has been extended with the role of lagged household debt, house price, interest rate, inflation rate, and unemployment. The change in the stock of debt is regressed on its own lagged value (Hatropp, 1992).
Ortalo-Magne and Rady (1998) extended the framework by including the variable of housing price in the life cycle theory. Besides, Iacoviello (2008) stated that household debt increases because households want to smoothen their consumption in uncertain conditions rather than due to a significant gap between income and expenditure. Still, the decision of households to spend their money may infer the intention to take up loans. Meanwhile, Tudela and Young (2005) highlighted that the long-run increase in debt relative to income has mainly been associated with the rise in homeownership and the reduction in the level of inflation over the 1990s. From the macro panel view,
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Rubaszek and Serwa (2014) proposed that the model of household debt is a function of the interest rate spread, unemployment rate, income, and housing price.
Accordingly, based on the review of the theoretical evolution above, household debt (HD) is a function of lagged household debt (HDt-1), income (Y), consumption (CON), interest rate (LIR), unemployment rate (UN), inflation rate (INF), working population (WPOP), and house price (HPIR):
HD = f ( , Y, CON, LIR, UN, INF, WPOP, HPIR ) (2)
CONCEPTUAL FRAMEWORK
CONCLUSION
The study aims to explore the leading factors of housheold debt. The review of theorithical foundation of household debt follows the life cycle and permanent income hypothesis. The concpetual framework shows the housheold debt depends on the income, consumption, unemployment rate, inflation rate, working population, lending interest rate, and house prices. The discussion of this paper offers an implication to the policymakers to further their awareness of actively-rising household debt, especially when history has shown the nature of the debt cycle that may cause financial shocks that undermine economic health.
Household debt Lagged household debt
Income Consumption
Interest rate Unemployment rate
Inflation rate Working population
House price
977 REFERENCES
Ando, A., & Modigliani, F. 1963. The “life cycle” hypothesis of saving: Aggregate implications and tests. The American Economic Review, 53(1), 55-84.
Barnes, S. & Young, G. 2003. The rise in US household debt: assessing its causes and sustainability. Bank of England Working Paper No 206.Friedman, M. (1957). A Theory of the Consumption Function. Princeton: Princeton University Press.
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Hunt, C. 2015. Economic implications of high and rising household indebtedness. Reserve Bank of New Zealand, 78(1), 1-12.
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Mian, A., & Sufi, A. 2009. The consequences of mortgage credit expansion: Evidence from the US mortgage default crisis. The Quarterly Journal of Economics, 124(4), 1449-1496.
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