This essay asks you to draw on the module material and the extract to discuss the evolving relationship between household debt and the economic impact of a shock such as Covid. It emphasises, in particular, that you should compare and contrast the situation of low- and high-income households.
Please do not describe in detail the economic policies put in place to tackle Covid and the resulting lockdown; the focus of your answer should be thinking through the options and choices open to high- and low-income households when faced with an economic shock.
There are a number of opportunities to engage with the module context. For example, at least two of the module themes – changing economic and social context and different types of households – are in play. Then there is the relevant module content, which may include:
- the role of income and wealth – i.e. flows and stocks
- the opportunities for increasing income, both in the short-term and longer-term
- spending, budgeting and the distinction between essentials and non-essentials
- borrowing, in terms of decisions around and access to unsecured debt. It might also be the case that household income plays a role in the price (interest rate) of the debt available. You might even reflect upon how inflation might impact on the real cost of debt.Using the module materials and the extract below, discuss the evolving relationship between household debt and the economic impact related to the economic shock of Covid, with a particular focus on high- and low-income households.
Extract: Household debt and Covid
The Covid crisis has been unique in the UK’s recent history. The spread of Covid and the actions taken to contain it have had a large economic impact on UK households. Mitigating policies included the Coronavirus Job Retention Scheme (furlough), business rates holidays, the Bounce Back Loan Scheme and the reduction of the Bank of England base rate. However, despite this degree of public policy support, the crisis has hit incomes and employment opportunities.
But the share of households reporting being in financial difficulty has started to increase, particularly for households with unsecured loans – who tend to have lower incomes and are less likely to be in employment. These households are also less likely to have savings and have been less able to accumulate savings through the Covid crisis. This may make this subset of households more vulnerable to future shocks.
There are a number of ways that households with debt might respond to increased pressure on their finances. This includes cutting back on spending, drawing down savings, or falling into arrears on debt or other household bills. Further cuts in spending, particularly if severe, could amplify the downturn or drag on the recovery and present risks to financial stability.
So far, there is no evidence that higher levels of mortgage debt have amplified spending cuts during the crisis.
Our survey evidence suggests that, in response to a fall in income, those with unsecured debt were more likely to use savings through the crisis or take on additional debt, whereas those with mortgages were more likely to cut their spending. This may reflect the fact that mortgage borrowers are concentrated in higher income brackets, and are therefore likely to have a higher share of discretionary spending, which was more restricted by lockdown measures.
The extent to which household debt may yet play a bigger role in the Covid crisis will depend on the evolution of the pandemic and the resulting pace of economic recovery, which remain uncertain. It will also depend on how governments, households, businesses and financial markets respond to these developments.