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Families with debts doubly careful with money, study shows

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As the cost of living spirals, fresh figures show that when incomes drop families are twice as likely to change their spending, compared with when income rises.

The study seen by The Bank of England also reveals households with debts cut back whenever their income drops, not just during a financial crisis, as previously thought.

It has heavy implications for calculating the effects of monetary and fiscal policy and understanding families’ resilience to financial shocks like rising mortgage rates.

“If you have large mortgage payments and you lose your job, you are more likely to spend less, than you would spend more if you got a promotion,” explained economist Dr Apostolos Fasianos.

“Family spending decisions matter for economic policy affecting incomes and wages, and for policies aimed to stabilise the financial system which monitors how debt changes economic indicators such as interest rates and the price of goods. 

This means “raising interest rates to stabilise prices would have a larger negative impact on spending than an interest rate drop, especially when the economy has high levels of household debt,” the Brunel University London academic said.    

The team combined five surveys tracking tens of thousands of UK households over 25 years to see how individual families responded to changes in their incomes. They studied income, house value and debt alongside spending on ‘consumable items’ such as food and drink, clothing, transport, entertainment and holidays.

Families are twice as sensitive to falls in income like job loss as they are to increases in income, such as better pay, they found. People made the biggest cutbacks when their income dropped by more than 15%.

The fact people constantly tighten their belts in line with income drops not just during financial crises suggests policies linked to household borrowing should widen their focus to when there’s higher risk of unemployment or a drop in income.

A big rise in interest rates to combat inflation would squeeze household spending more than a drop in interest rates, especially when there’s a high level of household debt. This is why interest rate changes do more to stabilise output, employment and demand during a downturn than in an uptick.

“If fiscal spending needs to be effective,” says Dr Fasianos, “it has to be more generous than a fiscal tightening to achieve the same impact on consumption growth, especially when the economy has a lot of household debt.”