Household Debt and Business Cycles Worldwide

Abstract

An increase in the household debt to GDP ratio in the medium run predicts lower subsequent GDP growth, higher unemployment, and negative growth forecasting errors in a panel of 30 countries from 1960 to 2012. Consistent with the "credit supply hypothesis," we show that low mortgage spreads predict an increase in the household debt to GDP ratio and a decline in subsequent GDP growth when used as an instrument. The negative relation between the change in household debt to GDP and subsequent output growth is stronger for countries that face stricter monetary policy constraints as measured by a less flexible exchange rate regime, proximity to the zero lower bound, or more external borrowing. A rise in the household debt to GDP ratio is contemporaneously associated with a consumption boom followed by a reversal in the trade deficit as imports collapse. We also uncover a global household debt cycle that partly predicts the severity of the global growth slowdown after 2007. Countries with a household debt cycle more correlated with the global household debt cycle experience a sharper decline in growth after an increase in domestic household debt. The Great Recession has sparked new questions about the relation between household debt and the macroeconomy. Recent theoretical and empirical research recognizes that a sudden and large increase in household debt could lower subsequent output growth in the presence of monetary and fiscal policy constraints. Moreover, households may not internalize the macroeconomic effects of their own borrowing, making the economy susceptible to "excessive" credit growth. 1 However, empirical evidence on increases in household debt and subsequent economic performance is largely limited to the United States and the most recent global recession. A more systematic evaluation of the empirical relation between household debt and business cycles worldwide is needed in order to understand if recent events are representative of a broader pattern. This is important given the dramatic rise in household debt to GDP ratios over the last 50 years documented by Jordà et al. (2014a). This paper compiles data for 30 countries from 1960 to 2012 and provides several new results that highlight the importance of household credit shocks in driving business cycles worldwide.There are two broad hypotheses that relate household debt to business cycles. The "credit demand hypothesis" posits a positive relationship between current household borrowing and future income. Household borrowing in this view is driven by productivity or technology shocks that increase expected future income, spurring higher consumption and borrowing in anticipation. On the other hand, the "credit supply hypothesis" holds that higher household borrowing is driven by an expansion in the availability of credit. If there are plausible frictions such as nominal rigidities or monetary policy constraints, then households may borrow excessively which leads to an eventual slowdown in GDP growth.Distinguishing the credit demand and credit sup...

Household debt, expected economic conditions, and income inequality

“…Thus, the findings indicate that upsurges in household debt and income inequality contribute to slowing economic growth. This corresponds with the recent findings of Mian et al (), who find that increases in household debt correspond with subsequent decreases in economic growth.…”

“…Recently, thanks to work by Thomas Piketty (), inequality has come to the forefront of economic study. In addition, increases in household debt levels have been tied to economic stagnation and recessions by Mian et al () and many others. Also, in the past, many authors have linked decreasing yield spreads with poor future economic performance (Bikbov & Chernov ; Estrella & Hardouvelis ; Estrella & Mishkin ; Moneta ).…”

“…The increase primarily represents households' attempts to smooth consumption over time on the expectation of increases in future income (Dynan & Kohn ). Similarly, Mian, Sufi, and Verner () have suggested that over‐optimistic expectations about the future are likely to contribute to credit demand by households. Thus, observing the high leverage ratio of households has led many economists to explore the role debt plays in driving overall macroeconomic conditions.…”

“…Thus, observing the high leverage ratio of households has led many economists to explore the role debt plays in driving overall macroeconomic conditions. Mian et al () show that household debt matters for subsequent changes in economic conditions. Growth in household debt over a 3‐ to 4‐year period predicts subsequently lower output growth and increases in unemployment.…”

Types of bank loans and their impact on economic development: a case study of the Czech republic

“…The main idea behind the study is that excessive credit growth tends to weaken a banking system and increase infl ationary pressures, thereby undermining economic growth. Mian et al (2015) based their study on an analysis of the relationship between household debt and GDP. According to their results, the growth of household debt in relation to GDP predicts a lower growth in production and higher unemployment rates in the medium term.…”