The impact of household debt on the wealth distribution and inequality in China

A recent Chinese household survey shows heterogeneous debt-to-income ratio (DIR) and debt-to-asset ratio (DAR). We analyze the cyclicality and time-lag properties of debt increment with respect to consumption and asset accumulation using econometric methods, and examine the effect of debt on wealth distribution in China by applying heterogeneous asset grids and idiosyncratic returns. The Hamilton–Jacobi–Bellman problem solved with interpolation and nested-drift approaches suggests that debt relaxes the budget constraint but hinders asset accumulation among low-income/asset households, and the Gini index increases by around 0.11 in the presence of debt increment. We further demonstrate that the indirect effect of monetary policy via assets accounts for up to 20 percent of the total effect for households with high wealth endowments. However, the high DIR and DAR prevent the compensation of the indirect effect on output growth and consumption for households with low endowments, thereby decreasing the effectiveness of standard monetary policy.