Household Leverage and Fiscal Multipliers

We study the size of fiscal multipliers in response to a government spending shock under different household leverage conditions in a general equilibrium setting with search and matching frictions. We allow for different levels of household indebtedness by changing the intensive margin of borrowing (loan-to-value ratio), as well as the extensive margin, defined as the number of borrowers over total population. The interaction between the consumption decisions of agents with limited access to credit and the process of wage bargaining and vacancy posting delivers two main results: (a) higher initial leverage makes it more likely to find output multipliers higher than one; and (b) a positive government expenditure shock always produces a positive multiplier for vacancies and employment. The latter result is in sharp contrast with models in which some households do not have access to the financial market (RoT consumers), in which the implied labor market responses to fiscal shocks are inconsistent with the empirical evidence. We also find that the impact on GDP of consolidations is lower when consumers have a more limited capacity to borrow, and that increasing government spending in an episode of intense private deleveraging can still generate positive and significant effects on consumption and output, although the fiscal output (employment) multiplier decreases (increases) with the intensity of the credit crunch. In the model with indebted impatient households we also observe that output (employment) multipliers decrease (increase) markedly with the degree of shock persistence and increase with the degree of price stickiness.