Household Debt Revaluation and the Real Economy: Evidence from a Foreign Currency Debt Crisis

This paper examines how an increase in household debt affects the local economy using a foreign currency debt crisis in Hungary as a natural experiment. We construct shocks to local household debt burdens by exploiting spatial variation in households’ exposure to foreign currency debt during the large (over 30%) and unexpected depreciation of the Hungarian forint in late 2008. We first show that a shock to local household debt leads to a rise in default rates and a persistent decline in local durable and non-durable consumption. Next, we find that regions with greater exposure to foreign currency debt experience a persistent increase in local unemployment. Firm-level census data reveal that employment losses are driven by firms dependent on local demand. Exposed areas see a modest decline in wages, but no adjustment through reallocation toward exporting firms or migration. In addition to the direct effect of higher debt, we find evidence of local spillovers. Regional exposure to foreign currency debt predicts a decline in house prices and an increase in the probability of default for households with only domestic currency debt. Our results are consistent with demand and pecuniary externalities of household foreign currency debt financing.