GROWTH IN THE ADVANCED ECONOMIES HAS FALLEN BY NEARLY A PERCENTAGE POINT PER YEAR SINCE THE GLOBAL FINANCIAL CRISIS (GFC).
As a result, households have been left poorer than expected, and governments have struggled to raise tax revenue. With government debt reaching historical highs and budget deficits at elevated levels, it seems counter-intuitive to suggest what the world needs is more borrowing. The borrowing we have in mind, however, needs to be done by the private sector.
MICHAEL BIGGS
Head of Macro Strategy
THE PRIVATE SECTOR BORROWS TO INVEST
If it borrows too much, as it did in the early 2000s, it becomes over-levered and vulnerable to financial crisis. If it borrows too little, profitable investment opportunities are being forgone. Private sector borrowing is important for economic growth. For spending growth to be strong, private sector borrowing needs to rise. Since the GFC, however, new borrowing has remained low and growth has been anaemic.
But, while weak new borrowing may have hampered growth in the past, it has positive implications for the future. New borrowing is so low that it is unlikely to fall much further, and it shouldn’t require much private sector optimism for it to rise. If borrowing does pick up, perhaps triggered by interest rate cuts or an easing in bank regulations, growth should strengthen and asset prices could benefit.
In this piece, we examine the relationship between borrowing and growth, consider factors that could affect borrowing in future, and assess the implications for the economic outlook.
CREDIT, SPENDING AND THE BUSINESS CYCLE
The role of credit in the business cycle was largely neglected until 2008, according to the IMF.1 Although the GFC forced policymakers and market practitioners to pay credit more attention, we believe its role in the business cycle is still largely misunderstood.
The conventional approach when analysing credit is to compare credit growth with spending growth. Frequently, one hears that strong credit growth should boost spending growth, or that deleveraging might prove a drag on spending growth. This sounds reasonable, but it is in fact a mistake.
Spending is a flow variable. It measures activity over a period, such as a quarter. Credit, in contrast, is a stock variable. It measures the total amount of debt outstanding at a fixed point in time. It includes all past borrowing not yet repaid.
Comparing credit growth (a change in a stock) with spending growth (a change in a flow) is a stock-flow error – it mixes time dimensions and can thus produce misleading conclusions.
Spending in any period is affected only by the new borrowing that takes place in that period, and changes in spending should therefore be related to changes in that new borrowing. We call this change in new borrowing the credit impulse. If new borrowing rises, the credit impulse is positive and spending growth tends to be strong. If new borrowing falls (no matter how high it is), the credit impulse is negative and spending growth tends to be weak.
Credit growth is based on new borrowing. The implication of our argument is that spending growth depends not on whether credit growth is high or low, but whether it is rising or falling. This is made clear in Figure 1.
In year 1, the household earns 100 but borrows 10. It spends 110 and debt increases by 10, so spending rises 10.0% and credit growth 5.0%.
In year 2, the household only borrows 5. Spending falls from 110 to 105, but debt rises from 220 to 225. Credit growth is positive (+2.4%), but spending growth is negative (-4.5%).
In year 3, the household pays back 10 of its debt. Credit growth falls again and spending growth remains negative.
In year 4, if the household only pays back 5 of the debt, the flow of credit increases from -10 to -5. The pace of deleveraging slows, and spending rebounds from 90 to 95. Credit growth is still negative but, crucially, it is increasing.
The key point: fluctuations in spending growth are not well correlated with fluctuations in credit growth. But they are strongly correlated with changes in the credit impulse.
Figure 2 visualises this idea, plotting a hypothetical stock of credit over time. The slope shows the rate of new borrowing (credit growth), and the change in the slope represents the credit impulse. The two shaded areas are the important ones.
- Phase 2: credit growth is positive but slowing, so the credit impulse is negative and spending tends to be weak.
- Phase 4: credit growth is negative but rising, so the credit impulse is positive and spending tends to be strong.
Our perception is that many economists and market practitioners focus on credit growth when they assess the economic outlook. As a result, spending tends to disappoint when credit growth is high but falling (Phase 2) and tends to surprise positively when credit growth is low but rising (Phase 4).
THE EVIDENCE
If our description of the relationship between credit and spending is correct, then new borrowing should rise during expansions, peak when expansions mature and collapse during recessions. Figure 3 suggests this is broadly correct in the US.
The credit impulse is also well correlated with private demand growth (Figure 4). When the credit impulse is zero, real private demand growth is close to trend. Growth is above trend when new borrowing is rising and the credit impulse is positive, and below trend when new borrowing is falling and the impulse is negative.
Figure 3 shows how abnormal the latest cycle has been. In the five longest business cycles since 1970, new borrowing was low at the start of the expansion, increased steadily until it peaked at levels of around 14% of GDP, and then collapsed into the recession. After the GFC, new borrowing recovered reasonably quickly to 6% of GDP. But then the rebound stalled. Stable new borrowing meant the credit impulse averaged zero, and demand growth remained at trend. The sustained rebound in new borrowing and the period of above-trend growth usually seen after a recession never materialised.
It’s been no better since covid: new borrowing appears stuck at 5% of GDP. Advanced economies need new borrowing to rise to boost growth.
WHY BORROWING COULD RISE
Three factors may have contributed to subdued new borrowing over the past 15 years: the state of household balance sheets; developments in central bank interest rates; and bank regulations. But we believe the pressure from all three could reverse in the coming quarters. Why?
Household balance sheets have improved
Household borrowing was particularly strong during the early 2000s, and household debt reached 100% of GDP in both the UK and the US during the GFC. Some deleveraging after the crisis was to be expected.
Since then, household borrowing has remained at such modest levels that household debt ratios have fallen to 75% in the UK and below 70% in the US (Figure 5).
In countries like Ireland and Spain, the deleveraging has been even more marked. This is the largest balance sheet repair since at least World War II. At some point, households will feel they have deleveraged enough and that their balance sheets allow an increase in new borrowing.
Interest rates could fall
Intuitively, new borrowing is likely to be affected by the level of interest rates, and changes in new borrowing by the changes in interest rates. Households might choose to borrow more as interest rates fall. But, if rates stabilise at these lower levels, there is little reason why households should choose to increase their new borrowing further.
Figure 6, which plots changes in credit conditions as estimated by the US Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) against the credit impulse, suggests this intuition is correct. As credit conditions improve, new borrowing rises, and the credit impulse turns positive.
If a fall in interest rates is required to boost new borrowing, it might explain why new borrowing has remained so muted since the GFC. For most of the 2010s, interest rates were around zero and couldn’t be cut further. And, as rates couldn’t come down any further, they couldn’t induce new borrowing to rise. Now, however, policy rates in most advanced economies are much higher, giving central banks ample room to cut rates if inflation moderates.
Bank regulations have started to ease
The GFC was at least partly attributable to excessive lending. Subsequently, to make their financial sectors more resilient, many countries introduced regulations requiring banks to hold more capital and reduce leverage. These banking regulations may have reduced the likelihood of financial crises. But they also appear to have depressed lending.
In the UK’s previous two cycles, new borrowing surged to above 10% of GDP (Figure 7). Since 2010, it has struggled to remain above 3%. Have regulations weighed too heavily on bank lending, thereby killing the dynamism of the economy?
The policy debate seems to be coming to that conclusion, and in late 2025 the Bank of England reduced capital requirements on UK lenders. If the regulatory burden on banks continues to decline, their willingness to lend might increase. But will a rebound in demand be enough to boost GDP growth?
NEW BORROWING AND PRODUCTIVITY
In the UK, one of the biggest disappointments since 2010 has been productivity growth. Productivity is generally seen as a supply side story, whereas credit is more likely to affect demand. If an increase in new borrowing boosts demand but productivity growth remains poor, the result could be higher inflation. We would argue, in contrast, that robust demand provides the environment in which productivity growth can thrive. Strong demand implies higher levels of investment, which in turn could boost productivity. Firms are more likely to undertake productivity enhancing changes when they are expanding than when they are struggling for survival. Productivity growth is hard to understand and notoriously difficult to predict. At best, new borrowing is only one of many factors affecting productivity growth. Nevertheless, productivity growth has tended to be strong when borrowing is strong, and weak when borrowing is weak (Figure 8).
ACTING ON IMPULSE?
The private sector borrowed too much in the 2000s, but, since the GFC, it has borrowed too little. This may have played an important role in the subsequent subdued growth and disappointing productivity.
Current low levels of new borrowing should be a source of resilience for the economy. After all, recessions generally happen when new borrowing falls sharply, which is unlikely when the starting level is low.
If private sector borrowing were to rise, it could reinject some dynamism into developed market economies.
A positive credit impulse could strengthen GDP growth – and might even help increase productivity. In turn, robust nominal GDP growth should boost fiscal revenues at a time when the rise in public debt appears inexorable.
Fortunately, the conditions for a sustained credit recovery may be falling into place. A decline in interest rates, reinforced by banking deregulation, could stir the animal spirits and induce a prolonged increase in new borrowing. Robust growth would make many of society’s challenges easier to overcome. And a positive surprise in growth would also be very supportive for equities and other risk assets. ⬤
1 Vlcek and Roger (2012), Macrofinancial modelling at central banks
THE RUFFER REVIEW IN CONVERSATION
Watch Mike Biggs episode of Ruffer Radio where he and Investment Specialist Gemma Cairns-Smith unpack the 'credit impulse' further and discuss what it signals for the UK economy.
15 mins
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