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Welfare implications of the transition to high household debt

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  • Jeffrey R. Campbell
  • Zvi Hercowitz

Abstract

Aggressive deregulation of the mortgage market in the early 1980s triggered innovations that greatly reduced the required home equity of U.S. households. This allowed households to cash-out a large part of accumulated equity, which equaled 71 percent of GDP in 1982. A borrowing surge followed: Household debt increased from 43 to 62 percent of GDP in the 1982- 2000 period. What are the welfare implications of such a reform for borrowers and savers? This paper uses a calibrated general equilibrium model of lending from the wealthy to the middle class to evaluate these effects quantitatively.

Suggested Citation

  • Jeffrey R. Campbell & Zvi Hercowitz, 2006. "Welfare implications of the transition to high household debt," Working Paper Series WP-06-27, Federal Reserve Bank of Chicago, revised 2006.
    • Handle: RePEc:fip:fedhwp:wp-06-27
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    References listed on IDEAS

    as
    1. Zvi Hercowitz & Jeffrey C. Campbell, 2005. "The Role of Collateralized Household Debt in Macroeconomic Stabilization," 2005 Meeting Papers 120, Society for Economic Dynamics.
    2. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
    3. Benjamin M. Friedman, 1992. "Learning From the Reagan Deficits," NBER Working Papers 4022, National Bureau of Economic Research, Inc.
    4. Richard K. Green & Susan M. Wachter, 2005. "The American Mortgage in Historical and International Context," Journal of Economic Perspectives, American Economic Association, vol. 19(4), pages 93-114, Fall.
    5. Friedman, Benjamin M, 1992. "Learning from the Reagan Deficits," American Economic Review, American Economic Association, vol. 82(2), pages 299-304, May.
    6. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
    7. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    8. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
    9. Robert A. Becker, 1980. "On the Long-Run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households," The Quarterly Journal of Economics, Oxford University Press, vol. 95(2), pages 375-382.
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    Keywords

    Welfare; Debt; Mortgage loans;

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