Euro Area Household Debt

Excessive household debt has potentially large negative consequences for the macroeconomy, especially in periods of stress. When large segments of the population are heavily indebted, this can pose systemic risks to the economy at large, as seen in the 2008 global financial crisis, when the housing market collapse triggered widespread debt default and even political instability. After increasing fast before the global financial crisis, household debt as a percentage of disposable income the euro area stabilised, increased again following the COVID-19 shock to diminish with the inflationary shock. Although in aggregate the stock of euro area household debt is backed by a considerable stock of financial assets, the evolution of aggregate net financial wealth is not indicative of the macrofinancial vulnerabilities associated with high household debt. These vulnerabilities can be exacerbated in a context of increasing interest rates and declining growth, which increase the debt burden through its effects on the effort needed to service accumulated debt, the so called “Fisher dynamics†. This chapter shows that “Fisher dynamics†have contributed significantly to household debt developments in the euro area, both exacerbating additional households’ borrowing and undermining their deleveraging efforts in crisis periods. In the euro area, in crisis times such as the global financial crisis and COVID-19, “Fisher dynamics†have even become the driving factor of changes in debt. Projections regarding future interest and growth indicate that “Fisher dynamics†will be unfavourable in the medium-to-long term and will require euro area households to reduce their credit-financed primary expenditures relative to the average of the last five years to ensure household debt sustainability