The Role of Collateralized Household Debt in Macroeconomic Stabilization

Market innovations following the financial reforms of the early 1980’s relaxed collateral constraints on household borrowing. This paper examines the contribution of this development to the macroeconomic stabilization that occurred shortly thereafter. The model combines collateral constraints on households with heterogeneity of thrift in a calibrated general equilibrium setup. We use this tool to characterize the business cycle implications of realistically lowering required down payments and rates of amortization for durable goods purchases. The model predicts that this relaxation of collateral constraints can explain a large fraction of the actual volatility decline in hours worked, output, household debt, and household durable goods purchases. ∗We are grateful for the National Science Foundation’s support of this research through Grant 0137048 to the NBER. †Federal Reserve Bank of Chicago and NBER. e-mail: [email protected] ‡Tel Aviv University. e-mail: [email protected]