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Consumption, 'Credit Crunches' and Financial Deregulation

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  • Scott, Andrew

Abstract

We 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 Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1389.

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Date of creation: May 1996
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Handle: RePEc:cpr:ceprdp:1389

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Keywords: Consumption; Credit Constraint; Credit Crunch; Financial Deregulation; Precautionary Saving;

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Cited by:
  1. Emilio Fernandez-Corugedo & Simon Price, 2002. "Financial liberalisation and consumers' expenditure: 'FLIB' re-examined," Bank of England working papers 157, Bank of England.
  2. Emilio Fernandez-Corugedo & John Muellbauer, 2006. "Consumer credit conditions in the United Kingdom," Bank of England working papers 314, Bank of England.
  3. A. Bayar & K. Mc Morrow, 1999. "Determinants of private consumption," European Economy - Economic Papers 135, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  4. David M. Williams, 2009. "House prices and financial liberalisation in Australia," Economics Series Working Papers 432, University of Oxford, Department of Economics.
  5. Emilio Fernandez-Corugedo, 2002. "Soft liquidity constraints and precautionary saving," Bank of England working papers 158, Bank of England.
  6. David M. Williams, 2010. "Consumption, wealth and credit liberalisation in Australia," Economics Series Working Papers 492, University of Oxford, Department of Economics.
  7. John Muellbauer & Emilio Fernandez-Corugedo, 2004. "Consumer credit conditions in the UK," Money Macro and Finance (MMF) Research Group Conference 2003 70, Money Macro and Finance Research Group.

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