Household Debt and Macroeconomic Fluctuations
Summary (via Atif Mian Amir Sufi- voxeu)
US Congressional committees are now grilling bankers on the complex instruments that provided subprime mortgages with a veil of security. This column presents new evidence that subprime mortgages had more serious consequences – they were a key factor in the US housing-price boom. When house prices faltered, subprime mortgage holders defaulted en masse, eventually leading to the global crisis.
Introduction (via Atif Mian Amir Sufi -Voxeu)
There once was a decade in US history in which financial innovation led to a sharp rise in the flow of credit to households. Durable goods consumption increased dramatically as household debt climbed to over 100% of GDP. The subsequent economic downturn was tragic, and the severity of the malaise was closely related to the preceding rise in household leverage (see Eichengreen and Michener 2003, Mishkin 1978, and the chart from David Beim at npr.org).
Research has argued that the “drop in consumption resulted from the unique combination of historically high consumer indebtedness and punitive default consequences” (Olney 1999).
While the storyline sounds eerily familiar to our recent past, it in fact describes the decade preceding the onset of the Great Depression. The form of innovation was not subprime mortgages – it was instead instalment loans related to automobile purchases and other consumer durables – but the parallels are striking. Household debt for Americans went over 100% of GDP only twice in the last century, in 1929 and in 2006.
Excerpted Conclusion (via Atif Mian & Amir Sufi – voxeu)
Going forward, policymakers and regulators should appreciate the role of household debt in asset price movements and macroeconomic fluctuations, and they should complement their existing models with rigorous microeconomic analysis.