<B>The growing indebtedness of Spanish households</B>

Juan Carlos Martínez Lázaro. Professor. Instituto de Empresa

9 January 2006

Household debt has grown sharply in Spain in recent years, boosted by increased consumer confidence and low mortgage rates. But recently, the European Central Bank moved to hike its key interest rate by one-quarter-percent to 2..25%.

Although the move itself isn’t significant, it raises questions about further rate increases and their potential impact on both Spanish households and the economy as a whole. Should efforts be made to cool off the booming housing market? What will the effects on our economy be?

Concern has grown lately over the troubling imbalances of the Spanish economy. Economists are worried about Spain’s persistent inflation rate differential, particularly with other European Union members, and the growing trade deficit.

But little has been said of rising household debt. According to recent data released by the Bank of Spain, household debt increased by 18% in the second quarter of 2005, from the same period a year earlier, and now stands at 77.4% of Spanish Gross Domestic Product.

There are many reasons to explain this increase. First of all, consumer confidence has been boosted by a sharp rise in employment rates and a general feeling of economic wellbeing, particularly compared to the rest of the EU. Confidence is vital when consumers make decisions such as buying a house or durable consumer goods.

Secondly, unprecedented low interest rates in the Spanish economy enable families to finance the purchase of homes or other large consumer goods, such as cars, at a very low cost. In this area, financial institutions have also played an important role by focusing heavily on home financing (in many cases by extending repayment terms) and other consumer services and goods.

Clearly, low interest rates and improved consumer confidence have prompted Spanish households to assume more debt. Growing household indebtedness can help sustain domestic demand; on the other hand, unbridled spending and growing debt levels can also negatively weigh on the economy in other ways.

The most obvious negative effect of growing household debt is the constant upward pressure it exerts on housing prices. The housing boom in Spain over the past few years can’t be explained without taking into account the above-mentioned factors. And although this may increase the wealth of homeowners, it also makes it difficult--if not impossible--for many low-income Spaniards to buy their first home.

What´s more, the strength of consumer spending--which has also pushed up family debt levels-- is closely related to inflation rates and to Spain’s trade imbalance. Imports have grown at two-digit rates in recent years due to the increasingly rapid growth of domestic demand.

Besides these direct effects on our trade balance, growing household debt has other latent risks that could have significant consequences for the economy. Further interest rate increases by the European Central Bank pose the clearest potential risk. The latest one-quarter percent rate increase doesn’t necessarily spell disaster for the financial health of Spanish families in the mid-term, even though many households have mortgages at variable interest rates. If it is, on the other hand, the first of several rate increases, then many Spanish families may end up struggling to make ends meet. Another factor that is hurting, and will continue to hurt, the financial strength of Spanish families is the rise in fuel prices. Fuel is not only more expensive, it also raises the price of other goods and services.

A serious problem could arise in this area: If higher interest rates crimp consumer spending, it could hurt job creation and boost unemployment significantly. The loss of one job and a salary could lead many families to default on their home loans.

In the mid-term, this scenario appears improbable, but it is still a latent risk for our economy. It’s clear, though, that it would greatly benefit our economy if the housing market cooled off, thus contributing to slow the growth of household debt. Weaker consumer spending would help narrow Spain’s inflation differential with the EU. And, if we could combine slower consumer spending with an increase in exports, we might even be able to correct our foreign trade deficit.


Dean Martha Thorne discusses her thoughts on the Pritzker Prize 2017

See video
Follow us
IE Focus Newsletter
IE Agenda
Most read
IE Business School | María de Molina 11, 28006 Madrid | Tel. +34 91 568 96 00 | e-mail: info@ie.edu


IE Business School

María de Molina, 11. 28006 Madrid

Tel. +34 915 689 600