saving households from insolvency – Peter Bofinger

Peter Bofinger argues that government guarantees on household loans could cushion the price shock at negligible cost.

Juggling rising bills (Redaktion93/shutterstock.com)

The war in Ukraine and its effects on global energy, metals and food markets are increasingly weighing on households. Since the beginning of this year, inflation in the euro zone has risen from 5.1 to 8.6%, although with considerable regional differences: in the Baltic States the rate is around 20%, in France by only 6.5%.

What is particularly worrying is that the wave of inflation is increasingly affecting food prices. For unprocessed foods, the euro zone rate reached 11.1% in June. And it’s unlikely to have peaked, as increases in gas prices, in particular, are usually passed on to consumers with some time lag.

These developments confront households with serious financial pressures. For Germany, the central association of the housing industry (GdW) expects additional charges for energy alone in 2022, compared to 2021, of up to €2,749 for one-person households and €5,074 for four-person households.

Expected additional annual costs (€) for energy in 2022 compared to 2021

Increase in 2022 already reached Projected total increase in 2022: low scenario Projected total increase in 2022: high scenario
All households 702 1,361 3,799
1 person 508 985 2,749
3 people 854 1,657 4,624
4 people 938 1,818 5,074
Source: GdW

Since low-income households spend a relatively large share of their budget on energy and food, they are particularly affected by the price spikes. As a study by Bruegel shows, in December 2021 the inflation rates faced by low-income people were respectively 1.4, 1.7 and 0.3 percentage points higher than those faced by people high income in Belgium, Italy and France.

These households generally have little savings or are already in debt. Without state aid, a wave of household over-indebtedness, with serious social consequences, is therefore to be feared.

Prize Cushion

In terms of economic policy, the optimal solution would be to temporarily cushion the price shock as much as possible, through interventions in the energy market and government transfers. Most countries already have corresponding support measures and programmes. But given the scale of the additional financial burden on households, full state compensation will not be possible.

Therefore, a public household loan program should be seen as an accompanying measure. The model is that of state-guaranteed loans given to companies on favorable terms during the pandemic, to avoid widespread insolvencies. In 2021, even before the spike in energy prices, in Germany, for example, 575,000 people attended debt counseling centers.

The amount of government guarantee should depend on the number of household members. Taking the high scenario above, for Germany the loan for a one-person household would be €2,750, €4,624 for a three-person household and €5,074 in the case of four people. The loan could be granted at an interest rate of 2 percent. Repayment (including interest) could be spread over five years, with no payment required for the first two.

The advantage for financially weak households would be, on the one hand, favorable interest rates. This avoids the debt trap, caused by the very high interest rates that must be paid for overdrafts. On the other hand, the availability of additional credit is useful when households are credit constrained, when rising energy costs would otherwise drive them into insolvency.


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State guarantee

Disbursement and settlement would be made through commercial banks, which would receive a government guarantee for this purpose. From the state’s point of view, the costs would be minimal, since it can borrow on the capital market at similar rates for this period.

Since public guarantees do not count as public debt within the meaning of the Maastricht fiscal rules, there would be no negative impact on debt levels. Of course, there would probably be a certain percentage of defaults, but that should be limited.

Theoretically, this program corresponds to the idea that households can borrow over time to cushion shocks. But in reality, the problem is that many households face credit constraints that deprive them of this possibility of adjustment. Government guarantees can eliminate friction.

This would save many people the difficult path to insolvency and at the same time allow a stabilization of private consumption. However, for the State, these guarantees have practically no cost, since it only transmits its solvency to households.

This is a joint publication of Social Europe and IPS-Journal

Peter Bofinger is professor of economics at the University of Würzburg and former member of the German Council of Economic Experts.

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