Household Debt Overhang Did Hardly Cause a Larger Spending Fall During the Financial Crisis in Australia

Working Paper: CEPR ID: DP16094

Authors: Lars E.O. Svensson

Abstract: The "debt-overhang hypothesis" - that households cut back more on their spending in a crisis when they have higher levels of outstanding mortgage debt (Dynan, 2012) - seems to be taken for granted by macroprudential authorities in several countries in their policy decisions, as well as by the international organizations that evaluate and comment on countries' macroprudential policy. New results for Australian microdata are presented that reject the debt-overhang hypothesis. The results instead support the "spending-normalization hypothesis" of Andersen, Duus, and Jensen (2016), what can also be called the "debt-financed overspending" hypothesis - that the correlation between high pre-crisis household indebtedness and subsequent spending cuts duringthe crisis reflects high debt-financed spending pre-crisis and a return to normal spending during the crisis. As discussed in Svensson (2019, 2020), this is consistent with the above correlation reflecting debt-financed overspending through what Muellbauer (2012) calls the "housing-collateral household demand" channel and Mian and Sufii (2018) the "credit-driven household demand" channel.

Keywords: Household Debt; Financial Crisis; Australia; Spending Normalization Hypothesis

JEL Codes: No JEL codes provided

Causal Claims

Cause	Effect
high pre-crisis household indebtedness (F65)	subsequent spending cuts (H56)
previous high debt-financed spending (H69)	high pre-crisis household indebtedness (F65)
high pre-crisis household indebtedness (F65)	normalization of spending during the crisis (H12)
overspending financed through housing equity withdrawal (G51)	normalization of spending during the crisis (H12)
credit supply shocks (E51)	normalization of spending during the crisis (H12)
optimistic expectations about future income (D84)	normalization of spending during the crisis (H12)