The Dynamics of Work and Debt

This paper characterizes the labor supply and borrowing of a household facing collateral requirements that limit its debt and compel it to accumulate equity in its durable goods stock. The household’s discount rate exceeds the market rate of interest, so it would otherwise finance increased current consumption by borrowing against future wages. Collateral constraints generate a positive comovement between the household’s debt, the stock of durable goods and labor supply following wage or interest rate shocks–as the household’s labor supply adjusts to finance downpayments on new durable good purchases and the subsequent debt repayment. Increasing the speed of debt repayment amplifies these movements. ∗We are grateful to Gadi Barlevy, Eric French, and Matthew Shaprio for their valuable input. Please direct correspondence to Campbell at Economic Research, Federal Reserve Bank of Chicago, 230 South LaSalle Street, Chicago, IL 60604-1413. e-mail [email protected] †Federal Reserve Bank of Chicago and NBER ‡Tel Aviv University