The theoretical relationship between household debt and economic fluctuations is not clear. On the one hand it could be argued that too much debt raises the sensitivity to monetary policy tightening or other shocks and hence would make private consumption more volatile. On the other hand, bank credit can be used to smooth consumption over the business cycle implying a lower volatility of consumption growth.

The following chart explores this relationship by looking at the ratio of household debt as a percentage of gross disposable income and the standard deviation of real private consumption growth (on a quarterly basis). The average and the standard deviation are calculated over the period 2000-2013.


One is tempted to visually draw a regression line with a positive slope, which would indicate that high debt levels are correlated with high consumption growth volatility. However a caveat applies: this ‘optical regression’ would be very much driven by the observation for Ireland, a country which indeed had a high level of debt and has gone through a boom and bust and hence has witnessed big fluctuations in consumption growth rates. For the other countries, it is striking to observe that the same consumption volatility can co-exist with very different debt levels (compare France with Germany) or that the same level of debt can co-exist with very different volatilities in consumption growth (compare Germany to Finland; compare Japan, the US, Portugal and Spain; compare Canada, Sweden, the UK, South Korea).

The conclusion is twofold:

  1. fluctuations in consumption growth seem to be driven by many factors: countries with stable consumption growth can have low or high debt levels and for a given debt level, countries can have stable or less stable consumption growth.
  2. countries with very high volatility of consumption growth have above average levels of household debt. Still, that does not mean there is causality although theoretically, as mentioned in the introduction, one can argue that high debt levels increase the sensitivity to shocks.