Household Leverage and the Recession

Thomas Philippon () and Virgiliu Midrigan

No 8381, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: A salient feature of the recent U.S. recession is that output and employment have declined more in regions (states, counties) where household leverage had increased more during the credit boom. This pattern is difficult to explain with standard models of financing frictions. We propose a theory that can account for these cross-sectional facts. We study a cash-in-advance economy in which home equity borrowing, alongside public money, is used to conduct transactions. A decline in home equity borrowing tightens the cash-in-advance constraint, thus triggering a recession. We show that the evidence on house prices, leverage and employment across US regions identifies the key parameters of the model. Models estimated with cross-sectional evidence display high sensitivity of real activity to nominal credit shocks. Since home equity borrowing and public money are, in the model, perfect substitutes, our counter-factual experiments suggest that monetary policy actions have significantly reduced the severity of the recent recession.

Keywords: Cash-in-advance; Household credit; Housing; Leverage; Monetary policy; Recession (search for similar items in EconPapers)
JEL-codes: E2 E4 E5 G0 G01 (search for similar items in EconPapers)
Date: 2011-05
New Economics Papers: this item is included in nep-cba, nep-mac and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (129)

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Related works:
Working Paper: Household Leverage and the Recession (2016)
Working Paper: Household Leverage and the Recession (2013)
Working Paper: Household Leverage and the Recession (2011)
Working Paper: Household Leverage and the Recession (2011)
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