Consumption, 'Credit Crunches' and Financial Deregulation
AbstractWe examine whether credit contributes to business cycle fluctuations by directly affecting consumption rather than through the now well-understood investment channel. Examining UK data we argue that consumers face a rising interest rate schedule whereby additional borrowing leads to higher interest rates. At a certain level of debt this schedule may become vertical and consumers face a credit ceiling. Using this assumption we find consumption growth depends on the interest rate, the borrowing wedge, and the debt-income ratio, and that we can potentially account for the failings of the rational expectations permanent income hypothesis (REPIH). Risk aversion and the interest rate schedule interact such that agents choose not to hold much debt, however, and so consumers are not much affected by ‘credit crunches’, although the more efficient the capital market, the bigger the impact. Calibrating our model and performing simulations suggests the sharp increases in UK consumption in the late 1980s were more likely due to income revisions than financial deregulation per se.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1389.
Date of creation: May 1996
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Other versions of this item:
- Scott, A., 1996. "Consumption, "Credit Crunches" and Financial Deregulation," Economics Series Working Papers 99181, University of Oxford, Department of Economics.
- E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
- E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
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