Statistics Canada recently released a study on how household’s financial expectations play a role in determining household debt.

Economists generally agree that households and business incorporate expectations about the future when making decisions. Generally, assessing how much expectations matter in decision making is difficult. The report uses Statistics Canada’s Survey of Financial Security (SFS) from 1999, 2005 and 2016 to examine whether a family’s expectation about their future financial situation impacts the level of debt they currently maintain.

The SFS includes the question, “In the next two years do you think your (family’s) financial situation will get better, worse or stay the same?”, which is used to examine whether families believe that have positive expectations carry higher levels of debt than otherwise comparable families. Generally, the analysis controls for age, education level, immigration status, family income after tax, family size, equity in principle residence, business equity, pension plan assets/RRSP, economic region, unemployment rate in region, home prices in region, and year effects. For instance, younger families are generally more optimistic about having an improved financial situation regardless of debt level and this is consistent with the typical pattern of stronger employment income growth during beginning of careers. The three years of SFS data are pooled as part of multivariate analysis with all monetary figures converted into 2016 dollars.  

Homeowner families who had more positive expectations about their future financial situation carried around $6,800 more in non-mortgage debt with this representing around 30 per cent of the average non-mortgage debt held by this family type. Among homeowner families, positive expectations of their future financial situation were associated with higher non-mortgage debt across all age groups, education levels, and for both immigrants and Canadian-born. Homeowners with positive expectations also reported higher levels of mortgage debt than other families. Renter families with positive expectations carried around $2,000 more in non-mortgage debt.

Debt-to-income ratios of homeowner families with positive expectations were 32 percentage points higher than other comparable families with the difference being substantial given that average debt-to-income ratio was 117 percent. Higher debt-to-income ratios were associated with positive financial situation expectations for all age groups, education levels, and immigration status categories among homeowners. Positive expectations among renters was associated with a 6 percentage point increase (average debt-to-income of 28 percent) but statistical significant results were only for persons 55 and older, those without university degree and Canadian born.

One limitation found was that the increase in overall household indebtedness over 1999 to 2016 was not due to rising positive expectations among families as the share of households with this view changed little over the period. Other factors such as preferences for bigger houses, maintaining status amid rising inequality or less aversion to indebtedness are possibilities. The study can not separate the reason for household’s positive expectation with the possibility that households with debt expect to pay it down and this is why they expect their financial situation to be improved in two years.

Source: Statistics Canada, Financial Expectations and Household Debt