Household Debt Overhang and Unemployment

Abstract

We use a labor‐search model to explain why the worst employment slumps often follow expansions of household debt. We find that households protected by limited liability suffer from a household‐debt‐overhang problem that leads them to require high wages to work. Firms respond by posting high wages but few vacancies. This vacancy posting effect implies that high household debt leads to high unemployment. Even though households borrow from banks via bilaterally optimal contracts, the equilibrium level of household debt is inefficiently high due to a household‐debt externality. We analyze the role that a financial regulator can play in mitigating this externality.

Household Liquidity Constraints and Labor Market Outcomes: Evidence from a Danish Mortgage Reform

“…A third channel is that high debt levels could change incentives to work caused by household protection under limited liability, referred to as “household debt overhang” by Bernstein (2021). Theoretically, Donaldson, Piacentino, and Thakor (2019) argue that highly levered households would reduce their labor supply when a portion of their marginal income is transferred to a lender via increased expected liability repayment. Empirically, Bernstein (2021) and Di Maggio, Kalda, and Yao (2019) show that high levels of mortgage debt and student loans reduce labor supply and wages.…”

“…In particular, when the housing equity is negative, households may engage in strategic default (Mayer et al (2014)), which might hurt job performance. Another strand of literature shows that high levels of mortgage or student debt have a "debt overhang" effect, leading to reduced labor supply and investment (Herkenhoff andOhanian (2011), Melzer (2017), Fos, Liberman, and Yannelis (2017), Di Maggio, Kalda, and Yao (2019), Donaldson, Piacentino, and Thakor (2019), Ji (2021), Bernstein, Mcquade, andTownsend (2021), Fontaine, Jensen, andVejlin (2023)). The Danish mortgage reform expanded credit access for homeowners while keeping other parts of the household balance sheet fixed, which allows us to isolate the effect of liquidity constraints from financial distress and debt overhang effects.…”

Financing the Gig Economy

“…My paper studies similar financial decisions but for the purpose of production. Similarly, while recent studies examine the connection between employment and consumer finance (e.g., in Dobbie et al (2020), Donaldson, Piacentino, andThakor (2019), andHerkenhoff, Phillips, andCohen-Cole (2021)), my study examines the direct link between household financial access and the ability to work in a market that requires household capital. My findings complement literature evaluating the size and benefits of the financial system, such as Greenwood and Scharfstein (2013) and Philippon (2015), by highlighting another important role of consumer finance.…”

Import Competition and Household Debt

“…It could also be the case that credit demand is driven by ratchet effects in consumption, whereby affected households increase their credit demand to maintain consumption levels, even if the shock is perceived as being long-lasting. Yet, another interpretation is that affected households lever up to invest in human or physical capital in response to the shock rather than to smooth consumption.5 See, for instance,Benmelech, Bergman, and Seru (2011), Chodorow-Reich (2014), orBarrot and Nanda (2020).6 See, for instance, Mondragon (2014)Ganong and Noel (2019),Donaldson, Piacentino, and Thakor (2019),Herkenhoff, Phillips, and Cohen-Cole (2021),Bos, Breza, and Liberman (2018), orBernstein (2016).…”