I'm not talking about government debt. I'm talking about the debt of households and firms. And I'm talking long run, not just the last few years. Over the last several decades, the ratio of debt to GDP has increased a lot. Not just in Canada, but in most rich countries, as far as I know. Why?
I don't have a good answer to that question. Or rather, I have several answers, but I don't know if any of them are good answers. I'm not sure if any of the effects I'm talking about are big enough to matter. And I'm not sure if they fit all the facts.
So I'm going to crowd-source the question.
I'm a bit hesitant to do this, because I know that this is one of those questions that excites popular opinion. And sometimes (not always) excited popular opinion just doesn't make sense. SO PLEASE READ THIS BIT FIRST:
Here are two popular "explanations" that don't add up:
1. "Everybody has been borrowing and spending too much!"
To get debt, you need both a borrower and a lender. Demand and supply. If everyone was borrowing and spending more than their income….they couldn't. Because there would be nobody lending and spending less than their income.
2. "The banks created loans out of thin air, and lent too much!"
Now, banks can indeed create money and loans out of thin air. And when they do that, and people spend the money they borrowed, we get an increase in aggregate demand and a short run boom. But we aren't talking about short run booms here, that last a couple of years. We are talking about a long run secular phenomenon that has trended up over decades. In the long run, when the economy is neither in boom or recession, the demand for loans from people who want to spend more than their income must match the supply of loans from those who want to spend less than their income. Banks can create loans out of thin air, but they can't create real saving out of thin air when real income is bolted down to the long run equilibrium trend line.
So, before answering, think about both the supply and the demand side.
Here are my "explanations", for what they are worth. I think they make theoretical sense, and are not obviously wrong, but I wouldn't claim any more than that.
1. Demographics. Globally, people are living longer, and expect to retire before they die. They want to save for their retirement. Plus, there have been a wave of boomers in many countries (with different dates). Young adults want to borrow to invest in education, houses, kids, cars, etc.. Maybe, just maybe, the world population has had an increasing proportion of people both in the big lending years and in the big borrowing years. So both supply and demand for debt increased, with interest rates adjusting to make up any small differences.
2. Growth of pension plans. Suppose you don't have a pension plan. You save to buy your own investments, like house and land and business, which you can use to finance your retirement. There's no debt. If you do have a pension plan, all your savings go into the pension plan, and you borrow (from someone's pension plan) to buy your house and land and business. So there's debt. Pension plans create intermediation where before there used to be self-financed investments. This caused both the supply and the demand curves for debt to increase.
3. Falling transactions costs. Financial intermediation has gotten more "efficient" over time. The supply and demand curves for debt didn't shift, but it's hard for lenders and borrowers to do a deal. There are "transactions costs" to borrowing and lending, that create a wedge between the supply and demand curves. Over time, those transactions costs have gotten smaller, so the equilibrium quantity of loans has increased. It's just like when a reduction in transport costs brings more buyers and sellers together even for the same supply and demand.
4. The Great Moderation/Minsky. Over time, risks of unexpected inflation or deflation, and risks of booms and busts, and financial crises, and political and legal risks, have become smaller. So it's been perceived as safer to borrow and safer to lend. So both the supply and the demand for loans increased.
I don't really find any of those explanations especially convincing.
Remember, it's demand and supply. And if you shift only one curve, remember what should happen to interest rates?
Anyone got good graphs, showing private debt/income ratios back over several decades? (Canada good, but any countries good too.) I know I've seen them, and it's doubled or trebled or quadrupled or more since the 1950's. But I've forgotten where. Thanks.
Worthwhile Canadian Initiative 
Name Redacted: If central banks had kept interest rates below the natural rate for the last 50 years we would now all be in hyperinflation. Didn’t happen. NGDP grew at just a little above trend for a couple of years before 2008 in Canada.
The Arthurian: Congress? You mean the US Congress? That’s a very US-centric explanation for a global phenomenon.
“Banks can create loans out of thin air, but they can’t create real saving out of thin air when real income is bolted down to the long run equilibrium trend line.”
Getting closer …
“4. The Great Moderation/Minsky. Over time, risks of unexpected inflation or deflation, and risks of booms and busts, and financial crises, and political and legal risks, have become smaller. So it’s been perceived as safer to borrow and safer to lend.”
Put emphasis on the “perceived” part. Is the more and more currency denominated debt (whether private or gov’t) path actually an unstable or disequilibrium path for NGDP targeting and/or price inflation targeting?
“So both the supply and the demand for loans increased.”
Do banks have plenty of “loan supply” and are just waiting for demand?
wh10 said: “TMF, are you asking if that is a reason for the long-run trend? I mean I don’t really know the detailed history and haven’t lived through the century, so I really don’t know, but I think you could make a sensible argument of this. If not housing, then whatever collateral, as the economy develops and grows.”
That might be one reason. Calculated Risk has more than one post about the fed “curing” a recession by lowering the fed funds rate, having other interest rates follow, and having an increase in housing demand from more mortgage debt. It seems to me that is what has happened in the post WWII period.
“TMF: There are lots of explanations that go like this: “The rich can afford to save and the poor can’t afford to save, therefore inequality causes debt, as the rich lend to the poor”. These simple explanations typically ignore the lifetime budget constraint.”
What happens if the lifetime budget constraint is hit by the lower and middle class, and the economy depends on them to continue to borrow to make up for negative real earnings growth to keep spending and increase the amount of medium of exchange?
See:
The origins of the economic crisis
And:
http://bilbo.economicoutlook.net/blog/?p=13193
When will the workers wake up?
Gizzard said: “Borrowing via banks is not the same as me borrowing 1000 from Nick. It just isnt.”
Agreed!
“S=I+G-T+NX is a useful way of thinking about net private sector liabilities, but we are talking about an increase in gross debt.”
I’d rather see:
current account deficit = gov’t deficit + rich deficit + lower and middle class deficit
Add a stock of medium of exchange that flows.
“Why don’t they sell assets rather than borrow against them?”
because they are hoping the assets will continue to rise in value
K said: “This model, by the way, is how I think about Eggertsson-Krugman 2010. They used the fairly standard device of dividing the world into patient and impatient agents, which annoys me, …”
IMO, they should divide the groups into those experiencing negative real earnings growth by their budget and those experiencing positive real earnings growth by their budget.
“It was at long run equilibrium before the Great Depression. Then the GT, war, inflation, etc. pushed it temporarily below the LR equilibrium. And ever since, it’s been slowly rising back up towards the same LR equilibrium.”
And Min said: ” If you are not joking, Nick, please pardon me for scoffing. First, why should we think that there is any such thing as a long run equilibrium for GDP/debt? (I put the generally more slowly changing variable in the denominator. ;)) Even if the ratio is a feature of various economic equilibria or quasi-equilibria, why should any such state be favored? Second, the crash and depression are prima facie evidence of dis-equilibrium, as are the recent financial panic and our Not So Great Depression. Third, if there is such a long run equilibrium, why would it not be at a point of even greater inequality? Caste societies have maintained their equilibria for centuries. In 1929 the task of crushing the lower classes and creating castes was incomplete.”
I agree with Min that the high debt is a disequilibrium/unstable path.
Clarification: I’m not the Oliver who posted above. I’m the Oliver who has posted here and on many other blogs, often MMT, before and I demand my name back :-).
Steve Keen has some graphs on US private debt here
http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/
But now to your actual question:
I’d expand on point 2 and add to what JKH said above. GDP refers to the market value of all final goods and services produced within a country in a given period. So, pretty much per definition, if the amount of money per final good increases, an increasing amount must not be going into final goods and services. It can’t go directly into its final parking spot, because nobody takes on debt just for the hell of it. But most do take on debt to buy other financial or non financial assets with it. My guess is that rising asset prices themselves create an initial demand for mor debt. Supply is forthcoming because that’s how banks earn money. The sellers of the assets then have the choice of spending it on either final goods and services, thus adding to GDP, or on other assets or on nothing at all. I think you’re right to point out pension funds and the like as likely final resting places for cash, although in the current situation a lot of it seems to be sitting around as retained corporate earnings. The only remaining question is, why don’t people spend their money on final goods an services? My guess, which is also where Minsky comes in, is that with increasing wealth, financial safety becomes increasingly more important than maximising consumption. There is of course a Minskyesque buildup of instability inherent in such a trend. And one way to reverse the trend without having to revert to pre New Deal instability, would be to deliver the desired security, not through fancy schmany finance and self fulfilling asset bubbles, but by providing final goods and services.
Hope that made sense…