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The rise in US household debt: assessing its causes and sustainability

  • Sebastian Barnes
  • Garry Young

In this paper the causes of the rise in US household debt since the early 1970s are considered, using a calibrated partial equilibrium overlapping generations model. The model explains indebtedness in terms of a consumption-income motive, associated with consumption smoothing, and a housing-finance motive. A credit constraint on borrowing by the old is also introduced to explain why they do not borrow to finance homeownership late in life. Shocks to real interest rates and income growth expectations, combined with demographic changes, are considered to explain the rise in US household debt. The calibrated model is found to be able to explain many features of US household borrowing, both in aggregate and cross-section. In particular, it predicts that the debt to income ratio would have increased substantially during the 1990s and would be expected to continue to grow in coming years. However, the model is unable to account for rising indebtedness during the 1980s when high interest rates, lower income growth and an ageing population would have tended to reduce aggregate borrowing. Alternative explanations, possibly associated with financial liberalisation, may account for borrowing growth during that period.

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Paper provided by Bank of England in its series Bank of England working papers with number 206.

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Date of creation: Nov 2003
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Handle: RePEc:boe:boeewp:206
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