May. 25, 2015
Let’s assume that Jim has just had a sudden unexpected expenditure: a neighbour released a bull into his back garden and it destroyed his conservatory. Let’s assume that the conservatory is essential to Jim’s wellbeing, so it has to be fixed immediately. As a result Jim’s debts, which were previously small and well-managed, have now increased somewhat.
Obviously Jim can’t keep that debt hanging over him forever. What does he do?
Fortunately for Jim, the circumstances of his borrowing aren’t so different before and after the event. Interest rates are low and are predicted to stay low, and the terms of his credit haven’t changed a great deal despite his increased borrowing.
In fact Jim is lucky enough that his creditors won’t be too panicked even if he borrows twice as much as he is now. (If you think this unrealistic, think of it as the bank betting that the more Jim borrows the more likely he is to have a balance that they can charge him interest on when interest rates do rise.)
Jim has an income that was comfortably managing to pay his debts but now his debt payments are taking up a greater fraction of his income - to the point where his agreed repayments and essential costs combine to generate more debt. First, Jim can make some savings to account for this. However, he can’t eliminate all his spending or else he spoils his income (for example: he cannot earn if starving and will not be paid if he does not take the train to be present at work).
Naturally we assume that Jim can’t simply default.
We’ll assume that Jim is already in an optimal and legal tax situation, that he can’t earn more simply by withholding it from others who are due - after all, this is little more than default by another name.
Jim’s best chance at paying off the debt is to increase his income. He’d better do it sooner rather than later, as he has little idea of which way the economy will turn. He has some options for quick wins - he considers withdrawing from his pension scheme until the debt is paid. He could also cancel his home insurance (at least for a little while). He can ask for a raise but not for too much or he’ll simply be out on his ear and earning nothing.
The best thing Jim can do is to develop his current skills and adapt to new job opportunities in the hope of securing a better income. If he does this then chances are he will be in a stronger position after the debts are paid, he’ll be able to live comfortably, and start to build up a fund against future emergencies.
Jim is looking at a few years of not being able to get the latest iPad, cover himself in ridiculously ugly tattoos, or go out on the lash with his mates. He thinks this might not be a bad thing. His experiences of researching the evidence base for the most effective ways to sustainably increase his income has left him way of short term fixes to long term problems.
This post was inspired by this article by Paul Krugman: The Triumph of Unthinking.