Debt repayment - a virtue or a curse?

This useful article from the BBC looks at debt, repayments and savings for individuals in the UK. In July UK households actually paid back more debt than they took out for the first time since the Bank of England started recording this data 16 years ago in 1993. At the end of that month total household savings amounted to £1.1 trillion, and total outstanding lending to individuals stood at £1.46 trillion (which is almost a trillion more than in 1993). Of this, £1.23 trillion was mortgage debt and £231m was other forms of consumer credit. Households are now starting to get the message about repaying that debt, with the average individual paying back £10 more than they borrowed in July – but the average personal debt standing at £24,000 is going to take an awful long time to pay back at £10 a month.

This seems like a Good Thing, as the huge burden of personal debt that was built up in the UK during the era of easy credit can be reduced. However, it won’t help to speed our rise out of recession and may contribute to a shallow W or U shaped recession rather than a steeper V. Individuals are choosing to pay off debt rather than save. The low interest rates brought about by an historically low base rate, which Mervyn King suggested could last into 2011, give little incentive to the UK’s 35 million savers to build up a reserve, and make repayment of outstanding debt a more attractive option. But as savings are not increased, banks are not likely to lend. While lending rates may theoretically be low, banks are reluctant to lend without a large deposit and credit is harder to come by, giving households little encouragement to borrow and spend money in the economy, so that consumption is lower and the negative output gap cannot be closed. The marginal propensity to consume is reduced, but the marginal propensity to save has not risen, the difference is made up by paying off debt which will benefit the individuals but not, in the short term, economic recovery.