Nice post

I agree that one has to be very careful about comparing stocks with flows, and that discussions of the debt-income ratio can be quite misleading: a) because interest rates have fallen so much since the 1980s a larger stock of debt can be serviced with the same proportion of income; and b) debt may simply have risen in line with assets.

However, there are circumstances where discussing the debt-to-income ratio can still come in handy. First, debt has to be serviced out of current income. Thus a debt-to-income ratio convey information about how vulnerable the household sector is likely to be to a sudden increase in interest rates. Second, asset prices can be volatile, and as we know, subject to bubbles. Simply looking at leverage ratios can be misleading if increases in asset prices are not based on fundamentals. To my mind, if nominal credit is growing persistently faster than nominal income, it isn’t in of itself something to worry about. But at the same time, responsible policymakers do have a duty of undertaking analysis to determine whether there are good fundamental reasons for nominal credit growth to be growing more rapidly than nominal income, and what vulnerabilities might arise from it.

Another example of where comparing stocks to flows has some use is Australia’s external accounts. The interest on Australia’s net foreign liabilities have to be serviced out of current Australian income. An increase in net foreign liabilities as a share of GDP tells us that for a constant yield on liabilities, Australia’s net income deficit is likely to be higher, and consequently the CAD. Now, of course, there may again be fundamental reasons why an increase in the ratio of NFL to GDP is not a concern – but it suggests a vulnerability…

Anyway, thanks again for the informative post…

...] A Quickie on the Rights and Wrongs of Stats. This gives us a huge intertemporal disconnect where we are comparing one year against the cumulative results of over 100 years. If we run the above chart again, but this time we use like with like, flow with flow, we can see how things … [...