Household Debt Overhang and Transmission of Monetary Policy

Abstract

We investigate how the level of household indebtedness affects the monetary transmission mechanism in the U.S. economy. Using state‐dependent local projection methods, we find that the effects of monetary policy are less powerful during periods of high household debt. In particular, the impact of monetary policy shocks is smaller on GDP, consumption, residential investment, house prices, and household debt during a high‐debt state. We then build a partial equilibrium model of borrower households with financial constraints to rationalize these facts. The model points to the weakening of the home equity loan channel as a possible reason for the decline in monetary policy effectiveness when initial debt levels are high.

One Size Fits All? Monetary Policy and Asymmetric Household Debt Cycles in U.S. States

“…The rise in household debt and housing wealth after an increase in the MPSG is in line with the expected macro effects of looser monetary policy conditions (Jordà, Schularick, and Taylor , , Alpanda and Zubairy , Bauer and Granziera ). Accordingly, expansionary monetary policy lowers the cost of financing and reduces the real value of debt through higher inflation, facilitating the access to credit and thus encourages borrowing.…”

“…The paper falls into two different strands of the literature: (i) the interaction between monetary policy, household debt, and the macroeconomy, such as Bhutta and Keys (), Aikman et al. (), Alpanda and Zubairy (), Bauer and Granziera (), Di Maggio et al. (), and Jordà, Schularick, and Taylor (); and (ii) the relationship between monetary policy and regional asymmetries, such as Beraja et al.…”

Debt and Stabilization Policy: Evidence from a Euro Area FAVAR

“…Bernardini and Peersman (2015) …nd evidence that government spending is more e¤ective and has larger multipliers during periods of high private debt. On the other hand, Alpanda and Zubairy (2017) show that monetary policy shocks are less e¤ective at stimulating the economy during periods of high household debt. of economic indicators, including real output, employment, and in ‡ation.…”

“…On the other hand, Corsetti, Meier and Muller (2012a) consider data on 17 OECD countries and …nd that while the impact response of GDP to a government spending shock is smaller during a high debt or weak public …nance state, the di¤erences in responses across states are not statistically signi…cant. 2 1 Corsetti, Meier and Muller (2012b) show that because of the combined e¤ects of monetary and …scal policy on long term rates, anticipated spending reversal can have large positive e¤ects at shorter horizons. If households expect future decreased spending, then they expect it to reduce future in ‡ation and thus future policy rates.…”

“…If, however, the agents in the economy expect debt stabilization through government spending-i.e., a spending reversal in the future-then there can be larger short-run positive e¤ects on output. 1 Using a non-linear, neoclassical growth model, Bi, Shen, and Yang (2016) show that the e¤ects of government policy can di¤er in high and low public debt environments. Moreover, it can depend on several factors, including wealth e¤ects on labor supply and whether debt is stabilized using taxes or spending.…”