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Household Leverage and the Recession

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  • Thomas Philippon
  • Virgiliu Midrigan

Abstract

A salient feature of the recent U.S. recession is that output and employment have declined more in regions (states, counties) where household leverage had increased more during the credit boom. This pattern is difficult to explain with standard models of financing frictions. We propose a theory that can account for these cross-sectional facts. We study a cash-in-advance economy in which home equity borrowing, alongside public money, is used to conduct transactions. A decline in home equity borrowing tightens the cash-in-advance constraint, thus triggering a recession. We show that the evidence on house prices, leverage and employment across US regions identifies the key parameters of the model. Models estimated with cross-sectional evidence display high sensitivity of real activity to nominal credit shocks. Since home equity borrowing and public money are, in the model, perfect substitutes, our counter-factual experiments suggest that monetary policy actions have significantly reduced the severity of the recent recession.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16965.

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Date of creation: Apr 2011
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Handle: RePEc:nbr:nberwo:16965

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  1. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
  2. Gianluca Violante & Greg Kaplan, 2011. "A Model of the Consumption Response to Fiscal Stimulus Payments," 2011 Meeting Papers 243, Society for Economic Dynamics.
  3. Vasco Curdia & Michael Woodford, 2010. "Conventional and Unconventional Monetary Policy," Discussion Papers 0910-17, Columbia University, Department of Economics.
  4. Karl E. Case & John M. Quigley & Robert J. Shiller, 2011. "Wealth Effects Revisited 1978-2009," NBER Working Papers 16848, National Bureau of Economic Research, Inc.
  5. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  6. Veronica Guerrieri & Guido Lorenzoni, 2011. "Credit Crises, Precautionary Savings, and the Liquidity Trap," NBER Working Papers 17583, National Bureau of Economic Research, Inc.
  7. Emi Nakamura & Jón Steinsson, 2011. "Fiscal Stimulus in a Monetary Union: Evidence from U.S. Regions," NBER Working Papers 17391, National Bureau of Economic Research, Inc.
  8. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 23 Oct 2009.
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Cited by:
  1. Jorda, Oscar & Schularick, Moritz & Taylor, Alan M., 2013. "Sovereigns versus banks: credit, crises, and consequences," Working Paper Series 2013-37, Federal Reserve Bank of San Francisco.
  2. Wendy Nyakabawo & Stephen M. Miller & Mehmet Balcilar & Sonali Das & Rangan Gupta, 2013. "Temporal Causality between House Prices and Output in the U.S.: A Bootstrap Rolling-Window Approach," Working papers 2013-14, University of Connecticut, Department of Economics.
  3. Atif Mian & Amir Sufi & Francesco Trebbi, 2014. "Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(2), pages 1-28, April.
  4. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2013. "Household leveraging and deleveraging," Staff Reports 602, Federal Reserve Bank of New York.
  5. Kerwin Kofi Charles & Erik Hurst & Matthew J. Notowidigdo, 2013. "Manufacturing Decline, Housing Booms, and Non-Employment," NBER Working Papers 18949, National Bureau of Economic Research, Inc.
  6. Pierpaolo Benigno & Federica Romei, 2012. "Debt Deleveraging and The Exchange Rate," NBER Working Papers 17944, National Bureau of Economic Research, Inc.
  7. Roberto Álvarez & Luis Opazo, 2013. "Household Debt During the Financial Crisis: Micro-Evidence from Chile," Working Papers Central Bank of Chile 695, Central Bank of Chile.
  8. Patrick A. Pintus & Jacek Suda, 2014. "Learning Financial Shocks and the Great Recession," Working Papers halshs-00830480, HAL.
  9. Sumit Agarwal & Gene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Tomasz Piskorski & Amit Seru, 2012. "Policy Intervention in Debt Renegotiation: Evidence from the Home Affordable Modification Program," NBER Working Papers 18311, National Bureau of Economic Research, Inc.
  10. Luca Fornaro, 2012. "International debt deleveraging," Economics Working Papers 1401, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2013.
  11. Guido Lorenzoni & Veronica Guerrieri, 2011. "Credit Crises, Precautionary Savings and the Liquidity Trap," 2011 Meeting Papers 1414, Society for Economic Dynamics.
  12. Atif R. Mian & Amir Sufi, 2012. "What explains high unemployment? The aggregate demand channel," NBER Working Papers 17830, National Bureau of Economic Research, Inc.

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