What happens when, in boom times, households run up substantial debt through mortgages, personal loans and credit cards? When the economy starts to slump, the recession is deeper and the eventual recovery is much weaker, according to the International Monetary Fund.
In its new World Economic Outlook report, the IMF found that declines in economic activity aren’t only caused by falling home prices and the resulting crunch on household wealth. Prerecession indebtedness often makes contractions “more severe and protracted.”
In the five years before 2007, the ratio of household debt to income in advanced economies rose an average 39 percentage points a year to 138%. Debt in Denmark, Iceland, Ireland, the Netherlands and Norway peaked at more than 200% of income.
Those debts were then exacerbated by a potent mix of plunging property values, sliding incomes and rising unemployment. And now the deleveraging process -- in which consumers try to pay off or default on those debts -- is holding back the economy, according to the IMF.