Household Financial Distress and the Burden of 'Aggregate' Shocks
Abstract: The goal of this paper is to show that household-level financial distress (FD) varies greatly, meaning there is unequal exposure to macroeconomic risk, and that FD can increase macroeconomic vulnerability. To do this, we first establish three facts: (i) regions in the U.S. vary significantly in their "FD-intensity," measured either by how much additional credit households therein can access, or in how delinquent they typically are on debts, (ii) shocks that are typically viewed as "aggregate" in nature hit geographic areas quite differently, and (iii) FD is an economic "pre-existing condition": the share of an aggregate shock borne by a region is positively correlated with the level of FD present at the time of the shock. Using an empirically disciplined and institutionally rich model of consumer debt and default, we show that in the shocks dealt by the Great Recession and in the initial months in the COVID-19 pandemic, FD mattered. Our model implies that the uneven distribution of FD creates widely varying consumption responses to shocks. This is true even when subjecting regions (with differing levels of FD) to the same shocks, which highlights the importance of FD independently of its correlation with shocks.
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Description: Full text
Provider: Federal Reserve Bank of Richmond
Part of Series: Working Paper
Publication Date: 2020-09-15