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Do high debt payments hinder household consumption smoothing?

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Author Info
Kathleen W. Johnson
Geng Li

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Abstract

Recently, U.S. households have committed a rising share of disposable personal income to required principal and interest payments on household debt. Studies of the direct link between the household debt service ratio (DSR) and consumption show mixed results—perhaps because debt may instead alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households over the DSR distribution. We find that a high DSR alone does not indicate higher sensitivity of consumption to a change in income. However, we find evidence that the DSR may help identify borrowing constrained households. In particular, the consumption of households with low liquid assets and high DSRs is more sensitive than the consumption of other low liquid asset households. Although this effect of high DSR is not precisely estimated, it is large and robust to changes in the specification, suggesting that more work is warranted.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2007-52.

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Date of creation: 2007
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Handle: RePEc:fip:fedgfe:2007-52

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Keywords: Consumption (Economics) ; Debts; Public;

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  1. Jappelli, Tullio, 1990. "Who Is Credit Constrained in the U.S. Economy?," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 219-34, February. [Downloadable!] (restricted)
  2. Philippe BACCHETTA & Stefan GERLACH, 1997. "Consumption and Credit Constraints : International Evidence," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9707, Université de Lausanne, Faculté des HEC, DEEP.
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  3. Bound, John & Brown, Charles & Mathiowetz, Nancy, 2001. "Measurement error in survey data," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 5, chapter 59, pages 3705-3843 Elsevier. [Downloadable!] (restricted)
  4. Guy Debelle, 2004. "Macroeconomic implications of rising household debt," BIS Working Papers 153, Bank for International Settlements. [Downloadable!]
  5. Brian Bucks & Karen Pence, 2006. "Do homeowners know their house values and mortgage terms?," Finance and Economics Discussion Series 2006-03, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  6. Lusardi, Annamaria, 1996. "Permanent Income, Current Income, and Consumption: Evidence from Two Panel Data Sets," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(1), pages 81-90, January.
  7. Jonathan McCarthy, 1997. "Debt, delinquencies, and consumer spending," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Feb. [Downloadable!]
  8. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints And Interest Rates Matter For Consumer Behavior? Evidence From Credit Card Data," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 149-185, February. [Downloadable!] (restricted)
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  9. Mishkin, Frederic S, 1976. "Illiquidity, Consumer Durable Expenditure, and Monetary Policy," American Economic Review, American Economic Association, vol. 66(4), pages 642-54, September. [Downloadable!] (restricted)
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  1. Karen E. Dynan & Donald L. Kohn, 2007. "The rise in U.S. household indebtedness: causes and consequences," Finance and Economics Discussion Series 2007-37, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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