Household Leverage and the Recession

49 Pages Posted: 19 May 2011

See all articles by Virgiliu Midrigin

Virgiliu Midrigin

New York University (NYU) - Department of Economics

Thomas Philippon

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

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Date Written: May 2011

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

JEL Classification: E2, E4, E5, G0, G01

Suggested Citation

Midrigin, Virgiliu and Philippon, Thomas, Household Leverage and the Recession (May 2011). CEPR Discussion Paper No. DP8381, Available at SSRN: https://ssrn.com/abstract=1846283

Virgiliu Midrigin (Contact Author)

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States

Thomas Philippon

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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