Avoiding Default: The Role of Credit in the Consumption Collapse of 1930

Abstract

High consumer indebtedness threatens future consumption spending if default is expensive. Consumer spending collapsed in 1930, turning a minor recession into the Great Depression. Households were shouldering an unprecedented burden of installment debt. Down payments were large. Contracts were short. Equity in durable goods was therefore acquired quickly. Missed installment payments triggered repossession, reducing consumer wealth in 1930 because households lost all acquired equity. Cutting consumption was the only viable strategy in 1930 for avoiding default. Institutional changes lowered the cost of default by 1938. When recession began again, indebted households chose to default rather than reduce consumption.

Inequality, Leverage, and Crises

“…Great Depression.-The crisis of 1929 was followed by a wave of defaults on automobile installment debt contracts (Olney 1999). The percentage of cars repossessed increased from 4.1 percent in 1928 to 10.4 percent in 1932.…”

“…Pre-Great-Depression.-According to Olney (1991) and Olney (1999), the ratio of non-mortgage consumer debt to income increased from 4.6 percent in 1919 to 9.3 percent in 1929. Around two-thirds of this was installment debt, especially for 1983 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1985 1990 1995 (Olney 1991).…”

Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises

“…An implication of both Eggertsson and Krugman (2011) and Guerrieri and Lorenzoni (2011) is that the immediate forgiveness of debt by constrained borrowers would alleviate the severity of recessions after a financial crisis. 1 The evidence goes back to at least Fisher (1933), and supporting evidence has been found in Mishkin (1978), King (1994), Olney (1999), Koo (2009), Mian and Sufi (2010, 2011a, 2011b, Mian, Rao, and Sufi (2011), and Glick and Lansing (2010). Jorda, Schularick, and Taylor (2011) study 200 recessions in 14 advanced countries from 1870 to 2008 and show a very strong relation between the ex ante increase in private debt and the ex post severity of the recession.…”

[Re-Examining the Contributions of Money and Banking Shocks to the U.S. Great Depression]: Comment

“…Real interest rates climbed to roughly 6% based on the GDP deflator and 9% based on the WPI. While the former is a broader-based index, the latter is likely measured with more precision, especially at the quarterly frequency.4 In addition to monetary tightening, credit conditions-particularly the weakness in consumer balance sheets and general household illiquidity in the wake of the stock-market crash-likely also contributed to the household spending drop, according to evidence presented by Mishkin (1978) and Olney (1999).…”