Do households with debt cut back their consumption more? New evidence from the United Kingdom

Apostolos Fasianos,Reamonn Lydon

doi:10.1111/boer.12317

Apostolos Fasianos, Reamonn Lydon

Open Access

https://doi.org/10.1111/boer.12317

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Abstract

AbstractWe investigate whether the debt position of UK households affects the response of nondurable consumption to income and wealth changes. We construct a novel estimate of nondurable consumption to track the same individual households over time for an extended period ranging from 1993 to 2017. Using this series, we explore how household indebtedness propagates negative and positive income and wealth changes to consumption responses. We assess whether negative and positive shocks imply the same consumption adjustments and whether such mechanism is crisis specific. Our evidence reveals that falls in income trigger substantially larger adjustments in consumption than income rises for households with debt, while the findings for wealth are less conclusive. The results also point to a macro‐financial link between a debt overhang and consumer spending, which carries implications for macro‐prudential policy makers aiming to ensure household resilience. These effects are not specific to the financial crisis period.

Highlights

Is the consumption of indebted households more sensitive to income shocks? The answer to this question informs our understanding of how indebtedness impacts macroeconomic dynamics
7 Our analysis focuses on nondurable consumption because the long-lived nature of durable goods provides the household with a flow of utility for multiple periods, which is hard to translate into consumption services for the time period associated to the income/wealth effect
This paper explored the sensitivity of UK households spending on nondurables to changes in their income and wealth, conditional on their level of indebtedness

Summary

INTRODUCTION

Is the consumption of indebted households more sensitive to income shocks? The answer to this question informs our understanding of how indebtedness impacts macroeconomic dynamics. Studies that look at individual household responses to income shocks by debt or wealth, such as Bunn et al (2018), Christelis et al (2019), and Drescher et al (2020), often use answers to hypothetical questions that ask households how they would respond to a temporary income shock These studies are usually limited to short sample periods or are prone to biases associated with online surveys. We show that the debt effects are present throughout the entire period of investigation (1993–2017) rather than only in the period following the global financial crisis, as reported in recent UK-related papers This finding implies that policies related to household indebtedness—be it fiscal, monetary, or macrofinancial—should not be focused solely on financial crisis periods and apply more generally when unemployment or income risk for (indebted) households is elevated.

INDEBTEDNESS AND CONSUMPTION DYNAMICS: A REVIEW

Survey data

Baseline results

Consumption responses to income shocks conditional on debt

Findings

CONCLUDING REMARKS