Household debt, the real economy, and financial stability: A literature review

The Global Financial Crisis of 2007-2009 moved research on household debt and its aggregate implications to the forefront of macroeconomics. In this review, we offer a synthesis of this large body of both empirical and theoretical research, and an overview of the most important themes for future research. Empirical studies robustly find that rapid aggregate household debt growth is associated with an increased incidence of financial crises and slower future economic growth. There is a broad consensus in the literature, both empirical and theoretical, that this statistical association is mostly driven by changes in credit supply and lending standards. This is also the dominant view of the drivers of the Global Financial Crisis, in particular in the U.S. However, the narrative emerging from the literature, heavily concentrated on the U.S. experience, is not easy to generalize. The mechanisms that define how credit expansions ultimately lead to responses in aggregate economic activity depend both on cross-sectional heterogeneity in household balance sheets and on local credit market institutions. These factors shape the credit constraints that households face, creating externalities that can ultimately cause large output losses and slow recoveries when the economy is faced with unexpected shocks. Overall, there remains many open questions in quantifying the relative importance of credit demand and supply factors in explaining observed household credit booms and busts, as well as in understanding the theoretical underpinnings of such cycles.