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IMF spells out dangers of increasing household debt

A sharp increase in household debt can boost growth in the short term but risks jobs, prosperity and financial stability in the medium term, the International Monetary Fund has warned.

Loading up households on credit is a seductive economic stimulant that should be avoided, particularly in countries where debt levels are higher than 30 per cent of GDP, the fund said. In Britain, the household debt-to-GDP ratio is above 80 per cent.

“In the short term, an increase in the household debt-to-GDP ratio is typically associated with higher economic growth and lower unemployment, but the effects are reversed in three to five years. These adverse effects are stronger when household debt is higher,” the IMF said. “Specifically, a 5 per cent increase in household debt to GDP over a three-year period forecasts a 1.25 per cent decline in real GDP growth three years ahead. Increases in household debt are also associated with significantly higher unemployment up to four years in the future.”

The IMF’s global analysis corresponds with Britain’s recent experience. Household debt to GDP jumped in the UK from roughly 60 per cent to 90 per cent between 2000 and 2007. In 2008, Britain collapsed into its deepest recession in a century.

Between 2010 and 2015, household debt-to-GDP levels fell, but they have crept back up since. Last month, the Bank of England said that it was not worried at the moment because private sector debt was rising in line with GDP.