Have Household Balance Sheets Improved That Much?

Those who contend that consumers are finally able to accelerate spending note that real consumer outlays jumped 3.4% last year after a long period of retrenchment. They argue that households have improved their balance sheets by whittling debt down to size. In particular, the critical ratio of installment debt to disposable income has fallen by an impressive 2.3 percentage points in recent years, to a seven-year low.

The problem, notes economist Francesca Eugeni of the Federal Reserve Bank of Chicago, is that installment credit has become an increasingly flawed measure of consumer indebtedness. In the latest issue of the bank's Economic Perspectives, she argues that the growing use of home-equity credit by consumers has muddied the debt picture.

It's hardly news that many homeowners shifted to home-equity borrowing after the Tax Reform Act of 1986 phased out the tax deductibility of interest payments on other forms of borrowing. What Eugeni has done is to assess this shift in terms of disposable personal income. In other words, she has asked the question: "Where would the ratio of installment debt to disposable income be if the shift had never taken place?"

The answer is revealing. By excluding borrowing for home improvements, Eugeni estimates that since early 1988, the part of home-equity debt used for the purchase of consumer goods and services has jumped from 3.1% of disposable income to 5.7%. And if this is added to installment credit, the consumer debt-income ratio has hardly declined (chart). Eugeni also notes that because of lower costs, consumers have been increasingly opting for auto leases rather than auto loans in recent years. And she estimates that the implicit debt incurred by the shift to such leases from 1986 to 1992 amounts to nearly a percentage point of disposable personal income. Thus, she says: "It appears that consumers have not reduced their debt levels at all."