Lowest income households borrowed to spend in run up to crisis

Low to middle income households were reliant on borrowing to fund much of their spending for more than a decade before the financial crisis, according to a new report for the independent think tank the Resolution Foundation.  The report reveals the full extent of the increase in borrowing and deterioration in household savings rates in the run up to the 2008/09 crisis, with the poorest 10% outspending their income by 40% by 2007. Given only a minority of the poorest are homeowners paying off their mortgage, it is highly unlikely this was counterbalanced by an increase in housing wealth.  

The report, authored by the National Institute for Economic and Social Research, found that over the 10 years 1997-2007, spending grew faster than incomes across all households, but for the poorest groups this was much more pronounced.  For the bottom 10%, incomes grew by 17% while spending grew by more than twice as much (43%).  Even middle income households found themselves falling behind, with incomes growing by 33% and spending growing by 46%, resulting in a negative savings ratio for a full ten years before the crash. The highest income households also saw their incomes grow by less than their spending over the period but still retained a positive – although declining – savings ratio.

Was there a link between inequality, household finances and the financial crisis?  Obviously, many other factors were also at work. But this evidence does suggest that it is possible that the increasing demand for, and supply of, credit to low income households may have reduced the sustainability of their debt burdens, and hence increased both the risks and the consequences of crisis.  

The report also looks at the implications of income inequality on growth going forward.  It finds that even substantial income redistribution would have little impact on the short term prospects for growth, though it doesn’t consider possible longer term impacts.

Gavin Kelly, chief executive of the Resolution Foundation said: ‘We all know by now that the debt position of households grew starkly worse in the run up to the financial crisis. But what this report exposes is the dramatic difference for lower income households who were way outspending their incomes by 2007. Looking to the future, we need growth that is sustained by gains spread across the whole income distribution – not ever more debt for those on the lowest incomes’.

Jonathan Portes, director of NIESR said:  ‘This research suggests that there may well have been a connection between the rise in income inequality in the years preceding the crisis and the rise in household borrowing, particularly for those on lower incomes. This doesn’t explain the last crisis or tell us what to do now. But it does I believe tell us that income inequality and income distribution matter for macroeconomic policy and the sustainability of growth. “

Notes to editors

The report will be discussed at an event on Tuesday 15 May 9.30-11am, with Jonathan Portes, Director, NIESR, Paolo Lucchino, Researcher, NIESR, Chris Giles, Economics Editor, Financial Times, Sir Tony Atkinson, Fellow, Nuffield College & Professor, London School of Economics & Gavin Kelly, Chief Executive, Resolution Foundation.

The report, Inequality, debt and growth was authored by Paolo Lucchino (NIESR) and Salvatore Morelli (University of Oxford) and is available to download on the Resolution Foundation’s website.