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Financial innovation and the Great Moderation: what do household data say?

  • Karen E. Dynan
  • Douglas W. Elmendorf
  • Daniel E. Sichel

Aggressive deregulation of the household debt market in the early 1980s triggered innovations that greatly reduced the required home equity of U.S. households, allowing them to cash-out a large part of accumulated equity. In 1982, home equity equaled 71 percent of GDP; so this generated a borrowing shock of huge macroeconomic proportions. The combination of increasing household debt from 43 to 56 percent of GDP with high interest rates during the 1982-1990 period is consistent with such a shock to households’ demand for funds. This paper uses a quantitative general equilibrium model of lending from the wealthy to the middle class to evaluate the positive and normative aspects of the transition to a high debt economy. Using the model, we interpret evidence on the changing distribution of assets and debt as well as macro time series since 1982.

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Volume (Year): (2006)
Issue (Month): Nov ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2006:i:nov:x:2
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