NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Household Leverage and the Recession

Thomas Philippon, Virgiliu Midrigan

NBER Working Paper No. 16965
Issued in April 2011
NBER Program(s):   AP   EFG   ME

A salient feature of the Great Recession is that regions that experienced larger declines in household debt also experienced larger declines in employment. We study a model in which liquidity constraints amplify the response of employment to changes in debt. We estimate the model using panel data on consumption, employment, wages and debt for U.S. states. Though successful in matching the cross-sectional evidence, the model predicts that deleveraging cannot, by itself, account for the large drop in aggregate employment in the U.S. The 25% decline in household debt observed in the data leads to a modest 1.5% drop in the natural rate of interest, and is easily offset by monetary policy. Household deleveraging is more potent, however, in the presence of other shocks that trigger the zero lower bound on interest rates. In the presence of such shocks household deleveraging accounts for about half of the decline in U.S. employment.

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This paper was revised on July 19, 2016

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Document Object Identifier (DOI): 10.3386/w16965

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