Consumption and credit constraints: a model and evidence from Ireland (original) (raw)

Do households with debt cut back their consumption more? New evidence from the United Kingdom

We investigate whether the debt position of UK households affects the response of nondurable consumption to income and wealth changes. We construct a novel estimate of nondurable consumption to track the same individual households over time for an extended period ranging from 1993 to 2017. Using this series, we explore how household indebtedness propagates negative and positive income and wealth changes to consumption responses. We assess whether negative and positive shocks imply the same consumption adjustments and whether such mechanism is crisis specific. Our evidence reveals that falls in income trigger substantially larger adjustments in consumption than income rises for households with debt, while the findings for wealth are less conclusive. The results also point to a macro-financial link between a debt overhang and consumer spending, which carries implications for macroprudential policy makers aiming to ensure household resilience. These effects are not specific to the financial crisis period. K E Y W O R D S consumption, debt, income, wealth This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited.

Housing Wealth and Household Indebtedness: Is there a Household 'Financial Accelerator'?

The 'financial accelerator' model when applied to households states that shocks to household balance sheets (primarily changes in house prices) amplify fluctuations in consumer spending by tightening or relaxing collateral constraints on borrowing. We construct an alternative model where households also have access to unsecured debt, and examine the effect of shocks to house prices on debt-financed consumption in this augmented setting. Our alternative model reduces the amplitude of fluctuations in debt-financed consumer spending arising from fluctuations in household asset values. The paper tests the applicability of the two models using panel data for the United Kingdom that allow us to measure collateral constraints, changes in asset values and financial indebtedness at the household level.

An econometric analysis of borrowing constraints and household debt

1991

A unique feature of the 1983 Survey of Consumer Finances (SCF) is that it enables the researcher to determine a priori which households would like to hold more debt than lenders will allow [e.g., Jappelli (1990)]. Based on these data, 30 percent of households under age 35 in 1983 faced binding borrowing constraints. To evaluate the effect of borrowing constraints, this study first estimates a bivariate probit model of who is not credit constrained and would like to hold positive debt. Controlling for selection effects, a debt demand function is then estimated using only unconstrained households that hold positive debt. Results indicate that households with strong intrinsic preferences for holding debt are more likely to be credit constrained, while lenders vary borrOWing constraints across borrowers on the basis of observable characteristics that proxy credit risk, consistent with "screening" models of credit rationing. As might be expected, unconstrained and constrained families exhibit significantly different behavior (at least with respect to their demand for debt). Moreover, of the constrained households in the sample, roughly half would hold substantially more debt if borrowing constraints were relaxed, ceteris paribus. These results prOVide one explanation for why empirical studies of household consumption and consumer spending frequently find evidence that is not consistent with a strict interpretation of the Life Cycle and Permanent Income Hypotheses.

Do High Debt Payments Hinder Household Consumption Smoothing?

SSRN Electronic Journal, 2007

Over the past fifteen years, U.S. households have committed a rising share of their disposable personal income to required principal and interest payments on household debt such as mortgages, automobile loans and credit card balances. This rise in the household debt service ratio (DSR) has generated interest of late because it could potentially cause households to cut back on their spending. This direct link between household debt and consumption has been studied in the literature, but the results of these studies are mixed-perhaps because debt may not have a direct effect on consumption growth, but rather may alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households in the Consumer Expenditure Survey over the DSR distribution. Our approach has two advantages relative to the existing literature. First, it avoids the most obvious source of endogeneity between debt and spending by studying the indirect effect of the DSR on the ability to smooth consumption through income fluctuations. Second, this approach is to our knowledge the first serious look at household-level DSRs, which vary substantially both across time and households. Our results indicate that households with relatively high DSRs are no less able to smooth through income fluctuations than other households. Rather, households with low or zero DSRs appear least able to smooth. This finding suggests that recent rises in the aggregate DSR could be welfare-enhancing to the extent they were the result of increased credit access to low-income households documented elsewhere.

Household Debt and Uncertainty: Private Consumption after the Great Recession

SSRN Electronic Journal, 2014

Household debt in many advanced economies has increased significantly since the 1980s and accelerated in the years before the Great Recession, resulting in an aggregate reduction of saving rates in the developed economies. Now, some of those economies are deleveraging, which may affect their recovery. We try to disentangle how these financial developments work for private consumption in a panel of oecd countries, after controlling for the traditional determinants (income, net financial and non-financial wealth and interest rates). We find that consistent with the perceived changes in the distribution of financial constrains across countries, aggregate consumption is also driven by the dynamics of housing debt accumulation and deleveraging.

Household Balance Sheets and Consumption Responses to Income Shocks

2019

We examine how households with different balance sheet positions respond to unanticipated transitory and permanent income shocks using panel data from the U.S. and Australia. Our main findings are the following. (i) the consumption response of households with higher debt to a transitory income shock is higher relative to households with lower levels of debt in the U.S. This group of households is distinct from households with low liquid wealth who also respond sensitively to transitory income shocks; (ii) the consumption elasticities from house price shocks are higher for households with higher debt in the U.S.; (iii) our time-varying estimates suggest that consumption of households with higher levels of debt exhibited greater sensitivity to transitory income shocks during the Great Recession and during the housing boom in Australia; and (iv) households with higher net wealth and lower debt have more consumption insurance against permanent income shocks. Our results provide new insi...

Consumption, Leisure and Borrowing Constraints

The B.E. Journal of Macroeconomics, 2012

We derive and estimate an aggregate Euler consumption equation in which non-separability between consumption and leisure and borrowing constrained households makes current consumption dependent on labour and asset (house) prices. Estimation results suggest that when labour is included in the aggregate consumption equation it proves to be more important than house prices in explaining the wide fluctuations in Finnish consumption data. Moreover, the evidence of excess sensitivity of consumption to income virtually disappears as the consumption Euler equation accounts for predictable changes in labour in the Finnish data.

A Dynamic Model of Money, Credit, and Consumption: A Joint Model for the UK Household Sector

Journal of Money, Credit, and Banking, 2005

Previous research has investigated consumers' expenditure and money demand as separable equations. We estimate them jointly as driven by the same influences. Credit is also included as a potential third variable that might provide a source of additional information about the monetary transmission mechanism. Consumption, money, and lending equations are modelled as an interdependent system, and the significance of lending for consumption and money is tested. The results using UK household sector data show that a stable credit equation does exist in parallel with money demand and consumption equations, and that interactions modelled in a conditional vector equilibrium correction system are favoured over independent equations.

The Balancing Act: Household Indebtedness over the Lifecycle

Microeconomics: Life Cycle Models & Behavioral Life Cycle Models eJournal, 2017

This article examines household indebtedness immediately after the Global Financial Crisis by comparing Ireland, the UK, the US, and the Euro Area. The article focuses on patterns of indebtedness across age-groups. The paper is the first to carry out this type of cross-country analysis of household debt burdens and its distribution across different household types. Compared to all other countries, Irish borrowers born from the mid-1960s through to the very early-1980s have substantially higher levels of debt – both in absolute terms and relative to their incomes. However, the low interest rate environment that has prevailed since 2008 has been particularly beneficial to these highly indebted Irish households, resulting in a debt-service burden (the ratio of debt repayments to income) that is broadly in line with that in other countries. However, in relative terms, a far greater proportion of Irish borrowers on variable rate loans are also exposed to potential interest rate rises in ...