The global tightening cycle that started in 2022 to curb surging inflation has been unprecedented in speed, size, and international synchronicity. While higher interest rates can dampen activity through many channels, one often-neglected channel may turn out to be particularly important going forward: rising private sector debt burdens associated with past borrowing.From a historical perspective, household debt levels in the U.S. as a fraction of GDP are high (Figure 1), even if they have come down substantially since the Global Financial Crisis (GFC). This deleveraging since the GFC has been facilitated by low interest rates, which prevailed for most of the post-crisis period and served to keep debt service costs manageable. Globally, household debt levels are equally at historical high levels, and many countries, such as Canada and Korea, have not seen any deleveraging since the GCF (also Figure 1). Hence, households and firms in the U.S. and many other economies may prove vulnerable to rapidly rising interest rates. Indeed, our research (Drehmann et al (2023)) highlights that past borrowing can cast a long shadow on economic activity.
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