Consumer Credit and Business Cycles
Sunday, Jan. 5, 2020 10:15 AM - 12:15 PM (PDT)
- Chair: Lukasz Drozd, Federal Reserve Bank of Philadelphia
Credit, Bankruptcy, and Aggregate Fluctuations
AbstractWe ask two questions related to how access to credit affects the nature of business cycles.
First, does the standard theory of unsecured credit account for the high volatility and procyclicality of credit and the high volatility and countercyclicality of bankruptcy filings found in U.S. data? Yes, it does, but only if we explicitly model recessions as displaying countercyclical earnings risk (i.e., rather than having all households fare slightly worse than normal during recessions, we ensure that more households than normal fare very poorly). Second, does access to credit smooth aggregate consumption or aggregate hours worked, and if so, does it matter with respect to the nature of business cycles? No, it does not; in fact, consumption is 20 percent more volatile when credit is available. The interest rate premia increase in recessions because of higher bankruptcy risk discouraging households from using credit. This finding contradicts the intuition that access to credit helps households to smooth their consumption.
Can the Unemployed Borrow? Implications for Public Insurance
AbstractDo the unemployed have access to credit markets? Yes. Do the unemployed borrow?Yes. We link administrative earnings records with credit reports and show that individuals maintain significant access to credit following job loss. Unconstrained job losers borrow, while constrained job losers default and delever. Both default and borrowing allow job losers to boost consumption, and they pay an interest rate premium to do so, i.e. the credit market acts as a limited private unemployment insurance market. We show theoretically that default costs allow credit markets to serve as a market for private unemployment insurance despite adverse selection and asymmetric information about future job loss. We then ask, given the degree of credit access households have, what is the optimal provision of public unemployment insurance? We find that the optimal provision of public insurance is unambiguously lower as credit access expands. The median individual in our simulated economy would prefer to have the replacement rate lowered from the current US policy of 45% to 35%. However, a utilitarian planner would actually prefer to raise UI relative to current US levels, even in the presence of well-developed credit markets.
Mortgage Debt, Consumption, and Illiquid Housing Markets in the Great Recession
AbstractUsing a model with housing search, endogenous credit constraints, and mortgage default, this paper accounts for the housing crash from 2006 to 2011 and its implications for aggregate and cross-sectional consumption during the Great Recession. Left tail shocks to labor market uncertainty and tighter down payment requirements emerge as the key drivers. An endogenous decline in housing liquidity amplifies the recession by increasing foreclosures, contracting credit, and depressing consumption. Balance sheets act as a transmission mechanism from housing to consumption that depends on gross portfolio positions and the leverage distribution. Low interest rate policies accelerate the recovery in housing and consumption.
- E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
- D9 - Micro-Based Behavioral Economics