Household Debt, Financial Balance, and Macroeconomic Stability: An Empirical Stock‐Flow Consistent Model of the UK Economy

This paper constructs an empirical stock‐flow consistent model (SFCM) for the UK economy (UKFINMOD) based on national accounts. Unlike many macro‐econometric models that focus solely on flow variables, SFCMs emphasize the importance of national balance sheets and ensure their consistency with flow variables. Without incorporating national balance sheets, macroeconomic models cannot fully capture the general equilibrium effects in the economy or model the interactions between the real economy and financial sectors. Using the UKFINMOD, this paper provides a detailed analysis of the household sector to identify potential macroeconomic instability caused by over‐indebtedness. This study, aligned with the sectoral financial balance approach used by Godley in 1999 and Godley and Zezza in 2006, intends to identify unsustainable economic trajectories. The financial stability of households is discussed under different economic backgrounds, including the housing‐credit reinforcing cycle and the new pension scheme in the United Kingdom that allows early pension withdrawals. These findings suggest that monitoring household debt‐to‐income ratios, along with financial balances, is essential for identifying financial crises. This alternative modeling strategy should be integrated into the suite of macroeconomic models, as proposed by Blanchard in 2018.