Discussion paper

DP11407 Household Leverage and the Recession

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 o set 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.


Philippon, T and V Midrigan (2016), ‘DP11407 Household Leverage and the Recession‘, CEPR Discussion Paper No. 11407. CEPR Press, Paris & London. https://cepr.org/publications/dp11407