For US and global economies, debt is a four-letter word

Already, it's clear that the US economy has been weakest – both during and after the recession – in regions where household debts are highest. That's the conclusion of county-level analysis by Amir Sufi of the University of Chicago, working with Atif Mian of the University of California, Berkeley, and Kamalesh Rao of MasterCard Advisors.

Even after two years of recovery, debt remains the economy's major challenge, says Mr. Sufi.

Debt may be dampening growth in a variety of ways, including:

Tighter credit. This affects consumers and small businesses through things like lower credit-card limits, closer scrutiny of mortgage applications, and higher bank fees since the recession. Part of the reason: Banks themselves are far from healthy, and regulators are calling on banks to boost their capital reserves as high rates of default on home loans persist.

A bust for family wealth. Before the recession, consumers were busy extracting cash from their houses (through home-equity loans and refinancing) – pumping cash directly into the economy. Now, after a drop in home values, many families with diminished net worth are trying to save more and spend less.

Diminished mobility. When people feel free to relocate, that helps the economy grow faster by using available labor in the most efficient ways. But between 2010 and 2011, a record low percentage of the population moved, according to recently released census numbers. One important reason appears to be inertia from the housing bust. Many people are staying put because they can't sell their homes at a price that would pay off their mortgage.

Leaner government spending. With many American voters worried about rising public debts, and credit-rating agencies issuing their own warnings, the climate for government spending has shifted sharply since 2009. Whether or not they believe more fiscal stimulus programs (like tax cuts or infrastructure spending) would be helpful right now, most economists say cuts in federal spending will reduce growth of the gross domestic product in the near term. Taking both state and federal governments into account, US fiscal policy is already restricting growth, by some estimates.

All this doesn't mean debt is the only obstacle in the path of a stronger recovery.

Some economists see other problems at the forefront. One camp, for example, argues that US government debts remain manageable in size (for now), and therefore the big policy failure is that fiscal stimulus programs haven't been big enough. Another camp argues that the missing ingredient for recovery is to get government out of the way by putting new regulations on hold (including the Obama health-care reforms) and by signaling resolve to restrain federal spending and keep future tax rates low.

Brian Bethune, an economist at Amherst College in Amherst, Mass., agrees with the notion that one big drag on consumers and businesses is uncertainty – doubts about everything from tax and health-care policy to the future trajectory of the economy. But he sees this problem as intertwined with debt.

"The two kind of feed on each other," Mr. Bethune says, and are "part of the same overall malaise that we're in."

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