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Household Debt Overhang and Unemployment

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  • JASON RODERICK DONALDSON
  • GIORGIA PIACENTINO
  • ANJAN THAKOR

Abstract

We use a labor‐search model to explain why the worst employment slumps often follow expansions of household debt. We find that households protected by limited liability suffer from a household‐debt‐overhang problem that leads them to require high wages to work. Firms respond by posting high wages but few vacancies. This vacancy posting effect implies that high household debt leads to high unemployment. Even though households borrow from banks via bilaterally optimal contracts, the equilibrium level of household debt is inefficiently high due to a household‐debt externality. We analyze the role that a financial regulator can play in mitigating this externality.

Suggested Citation

  • Jason Roderick Donaldson & Giorgia Piacentino & Anjan Thakor, 2019. "Household Debt Overhang and Unemployment," Journal of Finance, American Finance Association, vol. 74(3), pages 1473-1502, June.
    • Handle: RePEc:bla:jfinan:v:74:y:2019:i:3:p:1473-1502
    DOI: 10.1111/jofi.12760
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