MR JOHN LOOS

Low interest rates support the borrowing part of the Household Sector more than the highs of the late-1990s,….

It may be surprising to some to hear that the recent interest rate levels, with Prime Rate at 7% through most of 2021 and slightly higher at 7.75% currently, arguably represent a tougher interest rate environment for the consumer compared to 24 years ago back in 1998 where Prime Rate peaked at a “stratospheric” 25.5% around the middle of that year. But in a sense they do, for the Household Sector as a whole.

For those who are highly indebted and with little in the way of interest-bearing deposits, interest rates today are significantly more beneficial than back then.

In 2021, Household Sector interest payments totaled 5.5% of Household Sector Income. Admittedly, this was not the wonderful multi-decade low of 4.3% reached in 2004 at the height of the consumer spending growth boom. In that year, Prime Rate averaged a significantly higher 11.3%, but Household Sector indebtedness as measured by the Debt-to-Disposable Income Ratio was far lower back then, 54.7 at the end of 2004 compared to 66.2 at the end of 2021, thus containing debt-service costs more back then.

But compared to 1998, where Prime Rate averaged 20.5% in that year, the borrowing part of the Household Sector had it significantly easier in 2021, gross interest payments on debt averaging a high 9.2% of Household Sector Income 24 years ago.

From 9.2% in 1998 to 5.5% in 2021, however, is not as significant a drop as the decline in average Prime Rate over all those years. This is because, as interest rate cycles have shifted lower over the years, household indebtedness has merely moved higher. At the end of 1998, the Household Debt-to-Disposable Income Ratio was 54.1, compared to 66.2 at the end of 2021.

…But depositors earning interest are greatly disadvantaged compared to back then,….

But there is another side to interest rates that appears to be all but forgotten, i.e., the portion of the Household Sector that earns interest on deposits. The high interest rates of 1998 were far more beneficial to them, to the extent that their interest income was a very significant 7.1% of Household Sector Income. By 2021 that figure was a mere 2.4%.

…and the net result is that Household Sector “Net” Interest Payments/Income Ratio is higher today than back when interest rates were far higher.

To get the total direct financial impact of interest rate levels, therefore, one must calculate a “net interest payments” figure for the Household Sector, which is simply interest paid minus interest received, and express it as a percentage of Household Sector Income.

In 2021, Net Household Sector Interest Paid, expressed as a percentage of Household Sector Income, was 3.1%, higher than the 2.1% recorded in 1998.

In 2004, at the height of the consumer spending growth boom, this percentage was even lower at 1.7%.

The bottom line is that low interest rates of recent years aren’t quite as much of a consumer and retail stimulus as meets the eye, firstly because of significantly higher levels of household indebtedness compared to 2 decades or more ago, and secondly because one has to factor in the low level of interest income earned by deposit holders when interest rates decline or are very low.

And then there’s the personal tax burden to further offset the low interest rate stimulus

Finally, I thought it useful to add the direct tax impact into the mix.

The pre-2008 consumer boom not only benefited from the combination of relatively low interest rates and lower levels of Household Sector indebtedness than has been the case more recently, but households also benefited from lower tax rates back then.

Government itself had a far lower indebtedness ratio just over a decade ago, meaning less pressure on the fiscus. Total personal and wealth taxes expressed as a percentage of Household Sector Income, therefore, were a lowly 9.4% in 2004. In 2021 they measured 13.7%, implying an additional 4.3 percent of household sector income being taxed.

Finally, we add the total net interest payments and tax percentages together to get to the total Household Income/Wealth Taxes and Net Interest Payments on Debt, expressed as a percentage of Household Income.

In 2021, this percentage was lower than the 17.8% for 2020, mostly due to income recovering strongly after the 2020 lockdown dip, but still 5.7 percentage points above the multi-year low of 11.1% reached in 2004.

The combined direct impact of monetary and fiscal policy on the Household Sector is thus significantly less “Impactful” on the consumer and retail of late than was the case during the pre-2008 consumer boom years. In a country with far higher debt today than back then, low interest rates and aggressive cutting don’t have the same stimulatory effect on consumers and retail as they did back then.