How is the Riksbank handling the facts?

New Ekonomistas post (in Swedish). Here is an English translation.

The Riksbank maintains that household debt in Sweden is associated with risks and that this justifies a tight monetary policy resulting in low inflation and high unemployment. A representative statement about why household debt implies risks is given in a recent speech by the Executive Board member Kerstin af Jochnick (page 2):

We saw in the most recent financial crisis that high indebtedness in the household sector can create problems, with some countries suffering a severe fall in house prices. When the value of houses declines, households begin to save more. When savings increase, consumption decreases and thus demand in the economy falls. Ultimately, this can lead to lower production and higher unemployment. We do not want to see this kind of development in Sweden.

But is it really true that higher debt led to a larger fall in consumption and a larger rise in unemployment in the countries where housing prices fell during the financial crisis? Does this agree with the facts? 

Did higher debt bring a larger fall in consumption?

Whether the Riksbank’s statement is true or false can reasonably be decided by studying the data for the countries in questions. Figure 1 shows for a number of countries how much consumption increased from 2007-2012 (along the vertical axis) and how high household debt in 2007 was in relation to GDI.[1] According to the figure it does not seem true that higher debt brought a larger fall in consumption. (Click on the figures to enlarge them.)

hhdebt_dcons0712_swe

Figure 1. The increase in household consumption from 2007 to 2012 and household debt in 2007 as a proportion of GDI for a number of countries.
Source: OECD.

But the Riksbank’s statement refers to countries where housing prices fell during the crisis. Is it true that higher debt brought a larger fall in consumption in those countries?

Figure 2 shows the same thing as figure 1, but for the countries where real housing prices fell from 2007 to 2012. We see that there is no clear negative relation between household debt and the change in consumption.[2] The conclusion from these data is that it is not true that higher debt brought a larger fall in consumption for the countries where housing prices fell. (The households’ saving and consumption behavior is discussed more extensively in a previous Ekonomistas post (English translation).)

hhdebt_dcons0712_dhp_neg

Figure 2. The increase in household consumption from 2007 to 2012 and household debt in 2007 as a proportion of GDI for countries where real housing prices fell from 2007 to 2012.
Source: OECD.

Did higher debt bring a larger increase in unemployment?

The Riksbank’s statement refers not only to the fall in consumption but also to the increase in unemployment. Is it true that higher debt brought a larger increase in unemployment in countries where housing prices fell?

Figure 3 shows, for the same countries as in figure 1, how much the unemployment rate increased from 2007 to 2012 (along the vertical axis) and how large household debt was in 2007 in relation to GDI. There is no clear positive relation between the increase in unemployment and household debt in relation to GDI.

hhdebt_du_swe

Figure 3. The increase in the unemployment rate from 2007 to 2012 and household debt in 2007 as a proportion of GDI for a number of countries.
Source: OECD.

Figure 4 shows the same thing as figure 3, but for the countries where real housing prices fell from 2007 to 2012. Is it then true that higher debt is associated with a larger increase in unemployment for those countries? As we can see, there is no clear positive relation between household debt in 2007 as a proportion of GDI and the increase in unemployment from 2007 to 2012.[3] The conclusion from these data is that it is not true that higher debt brought a larger increase in unemployment in the countries where housing prices fell.

hhdebt_du_dhp0712_neg

Figure 4. The increase in the unemployment rate from 2007 to 2012 and household debt in 2007 as a proportion of GDI for countries where real housing prices fell from 2007 to 2012.
Source: OECD.

Thus, the Riksbank’s statement quoted above is simply not consistent with the facts. Overall, the conclusion is that the Riksbank’s justification for its focus on household debt does not stand up to scrutiny, something that is discussed in more detail in an earlier Ekonomistas post (English translation).

[1] OECD reports household debt as a percentage of GDI (Gross Domestic Income, GDP measured from the income side).

[2] A regression of the percentage increase of consumption on a constant and household debt as a percentage of GDI results in a coefficient of 0.00 with a standard error of 0.03 and a p–value of 0.99.

[3] A regression of the increase in percentage points of the unemployment rate on a constant and household debt as a percentage of GDI results in a coefficient of -0.01 with a standard error of 0.03 and a p-value of 0.69. If Greece, Ireland, and Spain are excluded, the  coefficient is 0.00 with a standard error of 0.01 and a p-value of 0.64. The coefficient is thus with a large margin not significantly different from zero.