Working Paper Revision

The Effects of Macroeconomic Shocks: Household Financial Distress Matters

Abstract: This paper investigates how, and how much, household financial distress (FD), arising from allowing debts to go unpaid, matters for the aggregate and cross-sectional consumption responses to macroeconomic risk. Through a battery of structural models, we show that FD can affect consumption responses through three channels: (1) as another margin of adjustment to shocks (direct channel); (2) because its persistence implies a significant degree of preference heterogeneity (indirect channel); and (3) because it can exacerbate macroeconomic risks whenever it is more severe in the hardest-hit regions, as evinced by the last two recessions (correlation channel). We find that all channels shape cross-sectional differences in the response of consumption to shocks. However, only the direct and indirect channels matter in the aggregate.

JEL Classification: D31; D58; E21; E44; G11; G12; G21;

https://doi.org/10.18651/RWP2020-13

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2024-01-04

Number: RWP 20-13

Related Works

• Working Paper Revision (2024-01-04) : You are here.
• Working Paper Revision (2021-10-20) : Financial Distress and Macroeconomic Risks*
• Working Paper Original (2020-10-05) : Household Financial Distress and the Burden of ‘Aggregate’ Shocks