Controlled consumer debt helps the economy to grow consistently. Lenders grant shoppers credit to buy goods and services that give the different industries reason to continue production and employment of workers. Excessive consumer debt, however, can bring the economy to a crawl and even cause it to reverse its course, and create a recession. But when the government and consumers address out-of-control debt, positive outcomes can also emerge.
Too much consumer debt overwhelms lenders. As borrowers fail to repay their loans or slow the repayment rate, institutions have less money to circulate. In addition, when default rates are high, banks protect themselves by granting credit to individuals with a solid credit history. At the same time, the banks deny less credit-worthy consumers the same privilege.
As institutions stop lending and individuals decrease consumption, the demand for houses, appliances, cars, manicures, vacations fall. People also postpone essential expenses until more money becomes available. The industries and professionals that provide the products and services respond in a number of ways depending on how resilient their businesses are. Some close their doors while others lower their prices. They also reduce salaries and lay employees off outright to survive. Any of these strategies reduces spending power. Would-be shoppers stop buying, pushing economic growth farther back towards a recession.
Low Interest Rate
A decrease in lending naturally leads to a reduction in consumer debt. When the central bank of the U.S. realizes that less people are borrowing, it can reduce the prime interest rate at which financial institutions borrow from each other. The measure causes other interest rates such as mortgage and car loans to also fall, making high-priced items more affordable. The Federal Reserve Board takes this step to keep trading going steady and prevent a severe economic slow down and recession.
It is possible for low prime rates to fail to stimulate the economy. Lenders continue to avoid parting with their money and consumers keep their distance from new spending as they wrestle with their debt. Such economic stagnation can affect other parts of the world. In a discussion about the U.S. economic downturn of the mid to late 2000s, the McKinsey Global Institute points out that, as Americans spent less, Asian exports dropped by as much as 35 percent. This dragged economies on the other side of the world down.
Personal Savings Boost
The McKinsey Global Institute observed that as spending fell due to large consumer debt in late 2000, personal savings rose. In 2009, individual savings rates increased to 5 percent and became the highest since 1995.
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