Households and recessions
Lessons from the US
By Jon Fernquest 
Households
and families, like companies, have balance sheets.A balance sheet for a household shows the financial position of the household at one point in time.
Year-by-year balance sheets for a typical or median household in the US from 2004 to 2007 are shown on the right. All figures are real figures in 2007 dollars (Source: James Kwak at Baseline Scenario on the US government's recent Survey of Consumer Finances).
Assets include: 1. money kept in the bank (bank accounts), 2. money being saved for old age and retirement, 3. cars and trucks owned (vehicles), and most importantly, 4. the family home (primary residence).
Liabilities include: 1. home loans (mortgage on primary residence), 2. loans for cars, refrigerators, and other household items (installment loans), and 3. credit card debt.
Net worth is the wealth of the household.
financial position - financial
situation, the money that you owe and the wealth you have accumulated
(the assets and liabilities that a company or individual possesses)
median - the middle item in a set of items arranged in order
real figures - adjusted for inflation over the years, so different years can be compared (inflation nearly always increases thus making comparison difficult)
an asset - a thing of value owned by a company or household such as property. money, or the right to receive payments in the future (financial instrument)
a liability - an amount of money that a company or household owes to another
equity, owner's equity, net worth - the current value of a company calculated by: assets - liabilities
primary - first and most important
residence - home, place where you live
primary residence - first and most important home, home that you live in most of the time
installment loans - loans that you pay back with several monthly payments
median - the middle item in a set of items arranged in order
real figures - adjusted for inflation over the years, so different years can be compared (inflation nearly always increases thus making comparison difficult)
an asset - a thing of value owned by a company or household such as property. money, or the right to receive payments in the future (financial instrument)
a liability - an amount of money that a company or household owes to another
equity, owner's equity, net worth - the current value of a company calculated by: assets - liabilities
primary - first and most important
residence - home, place where you live
primary residence - first and most important home, home that you live in most of the time
installment loans - loans that you pay back with several monthly payments
The equation that summarizes a balance sheet is:
Assets
= Liabilities + Net Worth
Net Worth, the value of the company, is given:
Net
Worth = Assets - Liabilities
If assets increase in value and liabilities decrease, then Net Worth or wealth increases. This, of course, is what a household wants.
If assets decrease in value and liabilities increase, then Net Worth and wealth decreases, what households don't want.
A
simple five sector model of the economy includes: 1.
Business sector (corporations), 2. Household sector, 3.
Financial sector, 4. Government sector, and 5. Foreign sector (See
diagram on right). Looking at the diagram, you can see that households supply their labour to the business sector and receive an income or wages in exchange.
Looking at the household balance sheet, household incomes stagnated and the median household income fell from $47,500 to $47,300 over the period 2004 to 2007.
Household-financial sector linkages
Households have always had to save for the future.This includes important items such as college tuition for children and a nest egg for retirement, paid for by the return from assets purchased with household savings.
These assets include retirement savings held in stocks, bonds, and bank accounts, as well as home equity built up over the years.
These household investment funds flow from households into the financial sector in the diagram above. The financial crisis has hit household savings hard:
"When
the crisis hit, though, the typical family took large hits in retirement
savings and in home equity that cost over one-third of its
net worth. So even though the typical household still has the jobs it
had before the crisis (unemployment is still “only” 7.6%), it is much
more worried about saving for whatever it has to save for - college
tuition, retirement, etc. - and hence much less willing to spring for the proverbial
flat-screen TV."
Households also borrow money from the financial sector. These are liabilities in the household balance sheet. In general, not much has changed here:
"The picture you get is surprising. From 2004 to 2007, the typical family only took on $4,900 more debt - mainly in mortgages, but some for installment loans (primarily for cars and education) - but its assets grew by slightly more, a little bit because of home values but more because of increased retirement savings, presumably due to the rise in the stock market."
"In
this picture, the typical family looks
reasonably prudent, although taking on 4% more debt with
no increase in income is not necessarily recommended."
Overall, taking into account both assets and liabilities, household balance sheets in the US have weakened over the last few years. They now have less valuable assets but the same liabilities, and therefore less net worth and more anxiety.
The decline in household wealth and net worth has caused households to cut consumption and save more.
Depressed consumption has been the single largest factor in the recent decline in US GDP.
(Also see economist Bruce Bartlett's column at Forbes on the same topic that cites online papers you can read)
a nest egg - money
saved up for retirement
took large hits in retirement savings - lost a lot of money they had saved for retirement
spring for the proverbial flat-screen TV - make a big purchase of a flat-screen TV (which is a typical big purchase)
prudent - careful, making reasonable and sensible decisions
looks reasonably prudent - prudent, but not overly prudent
anxiety - a feeling of nervousness and worry
took large hits in retirement savings - lost a lot of money they had saved for retirement
spring for the proverbial flat-screen TV - make a big purchase of a flat-screen TV (which is a typical big purchase)
prudent - careful, making reasonable and sensible decisions
looks reasonably prudent - prudent, but not overly prudent
anxiety - a feeling of nervousness and worry
