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Dashed expectations

Posted by Chris Farrell on Monday, February 23, 2009

There are a lot of factors accounting for the borrowing boom--and bust.

But one factor that may be underappreciated is that many people had a reasonable expectation that the borrowing would pay off.

Incomes typically pick up during an economic expansion, justifying the increased household debt. In a sense, the rule of thumb many of us carried in our mind was that a rising tide lifts all boats, right? Financial optimism had been the right approach for much of the postwar period. For example, according to the Economic Policy Institute, in the 1969 to 1979 economic cycle inflation-adjusted household income grew 4.5%, from 1979 to 1989 by 6.5% and from 1989 to 2000 by 8.3%.

It's the recnt period that different. From 2000 to 2007 real household income fell by 0.6%. What's happening today is a massive downward adjustment in growth expectations.

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