Financial Distress and Macroeconomic Risks

Athreya, Kartik B.; Mather, Ryan; Mustre-del-Rio, Jose; Sanchez, Juan M.

doi:10.20955/wp.2019.025

Working Paper Revision

Financial Distress and Macroeconomic Risks

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.

Keywords: Geography; Consumption; Credit Card Debt; Recession; Bankruptcy; Foreclosure; Mortgage; Delinquency; Financial Distress; Inequality; Poverty;