The OBR, personal debt and the living standards gap

The Resolution Foundation's Gavin Kelly and Matthew Whittaker look at whether squeezed households will really borrow more to prop up living standards.

By Gavin Kelly and Matthew Whittaker of the Resolution Foundation

The Office for Budget Responsibility caused a bit of a stir at the time of the budget when it suggested that household debt is set to rise over the rest of the parliament – from £1.6 trillion in 2011 to £2.1 trillion in 2015, or from 160% of household disposable income to 175%.

Rising debt will sit alongside lower savings, so that the ratio of household saving to disposable income falls to around 3½% – half its average over the last 50 years – for the duration of the OBR’s forecast period.

While the OBR last week published a little noticed note to clarify why it has changed its projections for household debt since last June, the underlying economic implications, and their impact on household living standards between now and the next election, remain largely unprobed.

The key question is whether the OBR is right about how households will react: is a further rise in personal indebtedness, already at historically unprecedented levels, a realistic account of how households at the sharp end of the living standards squeeze will behave over the medium-term in the post-crunch economy?

Theirs is a view that seems to run counter to a range of recent expert opinions and forecasts. For example, the Council of Mortgage Lenders has referred to the OBR projection on the scale of the increase in household debt this year as ‘wildly optimistic’ and at odds with its own forecasts, while PWC has projected household debt to be falling as a proportion of GDP throughout this parliament.

Roger Bootle of Deloitte has just marked down consumer spending growth in 2011 to -1%, and takes issue with the notion that household savings will fall further in the medium term, saying that tight credit conditions and the current weakness of consumer sentiment:

“[Will] surely mean that households will want to save more, rather than less.”

So much for the forecasters and pundits: what do the public say? Despite a well-documented shift from borrowing to saving since the start of the credit crunch, UK households remain severely debt-stressed. Bank of England polling data shows that at the end of 2010, half of all households said they were concerned by their level of debt.

At the same time, one-in-three households reported savings of under £500 – leaving little scope for protecting living standards by dipping into these funds.

Our own analysis at the Resolution Foundation shows that those on low-to-middle incomes face sharper constraints than better-off households. As the chart below shows, while around one-third (31%) of households in the top half of the income distribution said they were finding it harder to borrow to finance spending in 2010 than in 2009, among those on low-to-middle incomes this rose to over half (53%), up from just 16% in 2007…

…and these are exactly the people who are going to feel the fall in living standards most acutely and whom, presumably, the OBR expects to borrow more. Looking to the future, one-fifth of all households said they were saving more in anticipation of fiscal tightening. Just three per cent were planning on spending more.

Taken together these findings provide powerful grounds for asking what would happen if the OBR used different assumptions about how households may run down, as well as build up, debt during the prolonged fall in living standards. Without this, existing projections appear to be a bit of a punt.

Despite all the frothy rhetoric about the ‘re-balancing of the economy’ the growth of household consumption will be absolutely pivotal in the resumption of steady growth. Indeed, the key factor determining the strength of the UK recovery will be the uncertain reactions of millions of households, who are already close to the edge, to further falls in disposable income.

The question of whether ever more personal debt can be used to fill the growing living standards gap deserves far more serious scrutiny than it has received to date.

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