DP10865 Household Debt and Crises of Confidence

Author(s): Thomas Hintermaier, Winfried Koeniger
Publication Date: October 2015
Keyword(s): collateral constraints, consumer confidence, household debt, multiple equilibria
JEL(s): D91, E21, E32
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10865

We show that the size of collateralized household debt determines an economy's vulnerability to crises of confidence. The house price feeds back on itself by contributing to a liquidity effect, which operates through the value of housing in a collateral constraint. Over a specific range of debt levels this liquidity feedback effect is strong enough to give rise to multiplicity of house prices. In a dynamic setup, we conceptualize confidence as a realization of rationally entertainable belief-weightings of multiple future prices. This delivers debt-level-dependent bounds on the extent to which confidence may drive house prices and aggregate consumption.