Household Balance Sheets and Consumption Responses to Income Shocks

We examine how households with different balance sheet positions respond to unanticipated transitory and permanent income shocks using panel data from the U.S. and Australia. Our main findings are the following. (i) the consumption response of households with higher debt to a transitory income shock is higher relative to households with lower levels of debt in the U.S. This group of households is distinct from households with low liquid wealth who also respond sensitively to transitory income shocks; (ii) the consumption elasticities from house price shocks are higher for households with higher debt in the U.S.; (iii) our time-varying estimates suggest that consumption of households with higher levels of debt exhibited greater sensitivity to transitory income shocks during the Great Recession and during the housing boom in Australia; and (iv) households with higher net wealth and lower debt have more consumption insurance against permanent income shocks. Our results provide new insights into the relationship between household balance sheets and household consumption and how this relationship has changed over the Great Recession period.