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Title: Household Leverage and the Recession

Author(s): Virgiliu Midrigan and Thomas Philippon

Publication Date: July 2016

Keyword(s): great recession, Household Debt, Regional Evidence and zero lower bound

Programme Area(s): Financial Economics

Abstract: A salient feature of the Great Recession is that regions that experienced larger declines in household debt also experienced larger declines in employment. We study a model in which liquidity constraints amplify the response of employment to changes in debt. We estimate the model using panel data on consumption, employment, wages and debt for U.S. states. Though successful in matching the cross-sectional evidence, the model predicts that deleveraging cannot, by itself, account for the large drop in aggregate employment in the U.S. The 25% decline in household debt observed in the data leads to a modest 1.5% drop in the natural rate of interest, and is easily offset by monetary policy. Household deleveraging is more potent, however, in the presence of other shocks that trigger the zero lower bound on interest rates. In the presence of such shocks household deleveraging accounts for about half of the decline in U.S. employment.

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Bibliographic Reference

Midrigan, V and Philippon, T. 2016. 'Household Leverage and the Recession'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11407