Household Debt in Canada - Research Paper Example

? Introduction Consumer debt or personal debt is the debt outstanding against the individuals and not to the businesses or governments. In economics terms, it is also called the debt which is basically used in the consumption rather than making the investments. As against the businesses or governments which use debt to finance the investments however, consumers use debt for the purpose of consumption. Recent trends in Canada indicate that Canadians are having higher level of debt over the period of time despite the fact that there has been consistent cry about the worsening economic as well as financial conditions at the global as well as at domestic level. Recent figures suggest that the current level of personal debt in Canada is on the highest level for the past 8 years. The average non-mortgage personal loan of a Canadian is approximately $26,221 in the second quarter of 2012 suggesting that the overall debt levels are on the rise. (Johnson, 2012) There can be various reasons for this including the general trends and preferences of the consumers as well as the ability of Canadian banks to remain profitable and continue to supply consumer debt despite the fact that overall global scenario may not be encouraging. These trends are considered as troublesome as persistently high levels of personal debts can actually create serious consequences for the economy as a whole. This paper will discuss about the personal debt in Canadian society as a whole and will discuss the concerns as well as solutions for it. Personal Debt in Canada The recent trends of personal debt in Canadian society as a whole have been alarmingly high. The current average debt level in the second quarter of 2012 stood at $26,221 higher by $192 from the previous quarter. This figure is also considered as the highest during the last eight years since Credit Bureau actually started to track the personal debt levels. (Johnson, 2012) Studies have shown that debt to income ratio is on the rise as well as the debt-to total assets is on the rise too. These trends indicate that more and more portion of consumers’ income is taken by the debt and higher debt payments can actually reduce the disposable income for the individuals. Average annual growth rate of household debt in Canada grew by 7.4% in nominal terms and 5.3% in real terms during 2000-2011. Such consistent level of increase in household debt has actually put personal debt at the level which may not be sustainable for consumers in the long run. It is also important to note that this rise in the consumer debt is mostly in the non-mortgage debt class and is also secured against the household items. Such characteristics of the personal debt may therefore create significantly more economic consequences for the households. (Crawford & Faruqui, 2012) It has been suggested that such high level of personal debts can actually put Canadians at more vulnerability towards the economic shocks as any adverse change in employment dynamics can put lot of stress on the disposal income of the consumers. Sharp decline in home values as well as increase in interest rates as well as relatively higher level of unemployment can put individuals at more risk considering the current levels of debt in the country. (Chawla & Uppal, 2012) IMF has also shown its reservations over the higher levels of personal debt in Canadian economy and indicated that higher levels of personal debt can actually reduce the economic growth of the country. IMF has even cut its economic forecasts for Canada owing to higher personal as well as mortgage loans and suggested that higher debt levels at consumer level can actually create more risk for the economy as a whole. (BABAD, 2012) Some data indicates that this trend is on the rise across all ages and there are different factors which are actually at play causing the consistent rise in the personal debt levels. It has also been suggested that the persistent increase in the level of income as well as low interest rates have also contributed towards these trends. Some theoretical insights suggest that buying on debt actually increases the overall welfare of the family as a whole therefore individuals borrow in order to temporarily increase their welfare. However, consistently high levels of personal debt can actually reduce the disposable income as higher levels of payments will be going towards the adjustment of loans and thus households will have little income left. Such behavior not only has serious consequences for the individuals but for the financial system as a whole also as witnessed during current financial downturn. (Greenwood, 2012) What can be done? One of the main tools to discourage consumer debt is the interest rates as raising interest will make borrowing cost more costly. By increasing the interest rates charged to the consumers, tendency to acquire higher personal debt can be reduced and hence a sustained level of decline in the consumer debt can be experienced. In order to achieve this, central bank of Canada has to play a more active role in managing the interest rates at levels which can just ensure rational growth in the personal debt. By periodically reviewing the interest rates and making them more sensitive to the changing economic conditions, Central Bank can actually make adjustments in interest rates to discourage consumer credit. Another solution to this problem is credit rationing wherein financial institutions can actually put ceilings on the credit to be availed by individuals. By capping the amount of credit an individual can acquire, society as a whole can benefit because overall debt levels will be at the rational levels and that the households will not be put on the extra risk and will not be more vulnerable to external economic shocks. Another and potentially more important measure which can be taken is to increase the level of savings within the society. Increasing level of savings will actually provide consumers cushion against the adverse economic situation as well as provide them access to funds which they can use instead of borrowing the same for the consumption purposes at the later stage of their life. Encouraging savings within the society however may be a long term issue as it may not be possible to change the consumption habits of the consumers in short run. However, to decrease the level of personal debt, it is important that government must take efforts to increase the saving trends. This can be achieved either through offering tax efficient saving accounts to offer tax benefits to savers or increasing the interest rates on the deposits so that households can be attracted to make savings as their habit and therefore reduce their reliance on the personal debt. Conclusion Personal debt levels are on the rise in Canada as current level is at the highest for last 8 years. These higher levels of debt are considered as dangerous for overall society as higher personal debt make households more at risk from the external economic shocks. Current average debt level is over $26,000 and is all time high during last 8 years. Higher levels of income as well as low interest rates are considered as some of the factors actually resulting into this increase. It has also been argued that this rise in the debt levels has been across the range of different ages. These trends can be arrested by increasing the rate of interests as well as capping the per party credit limits allocated to each individual. Government should also encourage savings by offering tax-efficient accounts so that consumers can rely on their savings for purchasing purposes rather than use credit to buy things. Bibliography BABAD, M. (2012, Oct 09). IMF cuts Canada's outlook, frets over housing, consumer debt. Retrieved from The Globe & Mail: http://www.theglobeandmail.com/report-on-business/top-business-stories/imf-cuts-canadas-outlook-frets-over-housing-consumer-debt/article4597907/ Chawla, R. K., & Uppal, S. (2012, 03 03). Household debt in Canada. Retrieved from Statistics Canada: http://www.statcan.gc.ca/pub/75-001-x/2012002/article/11636-eng.htm Crawford, A., & Faruqui, U. (2012, Feb 02). What Explains Trends in Household Debt in Canada? Retrieved from Bank of Canada: http://www.bankofcanada.ca/wp-content/uploads/2012/02/boc-review-winter11-12-crawford.pdf Greenwood, J. (2012, August 28). Our love affair with debt keeps Canada’s banks on top. Retrieved from FP Street: http://business.financialpost.com/2012/08/28/our-love-affair-with-debt-keeps-canadas-banks-on-top/ Johnson, A. (2012, August 23). Canadian consumer debt level hits record high. Retrieved from CTV News: http://www.ctvnews.ca/canada/canadian-consumer-debt-level-hits-record-high-1.926424 Read More