DP16094 Household Debt Overhang Did Hardly Cause a Larger Spending Fall during the Financial Crisis in Australia

Author(s): Lars E.O. Svensson
Publication Date: April 2022
Date Revised: April 2022
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16094

The "debt-overhang hypothesis" - that households cut back more on their spending in a crisis when they have higher levels of outstanding mortgage debt (Dynan, 2012) - seems to be taken for granted by macroprudential authorities in several countries in their policy decisions, as well as by the international organizations that evaluate and comment on countries' macroprudential policy. New results for Australian microdata are presented that reject the debt-overhang hypothesis. The results instead support the "spending-normalization hypothesis" of Andersen, Duus, and Jensen (2016), what can also be called the "debt-financed overspending" hypothesis - that the correlation between high pre-crisis household indebtedness and subsequent spending cuts during the crisis reflects high debt-financed spending pre-crisis and a return to normal spending during the crisis. As discussed in Svensson (2019, 2020), this is consistent with the above correlation reflecting debt-financed overspending through what Muellbauer (2012) calls the "housing-collateral household demand" channel and Mian and Sufii (2018) the "credit-driven household demand" channel.