E¢ cient Credit Policies in a Housing Debt Crisis

During the …nancial crisis and its aftermath, those segments of the economy most exposed to the accumulation of mortgage debt have tended to fare the worst. Whether it is by industry (construction), by geography (sand states), or by household (the most indebted), the presence of greater mortgage debt has led to weaker economic outcomes (see for example, Mian and Su…, 2009, and Dynan, 2012). Moreover, research suggests that …nancial crises accompanied by a housing collapse may be more severe and be associated with slower recoveries (Reinhart and Rogo¤, 2009, Howard, Martin, and Wilson, 2011, and International Monetary Fund, 2012). These observations lead to an apparently natural macroeconomic policy prescription: restoring stronger economic growth requires reducing accumulated mortgage debt. In this paper, we consider this proposal in an environment where debt is indeed potentially damaging to the macroeconomy, but where the government and private sector have a range of possible policy interventions. We show that while debt reduction can support economic recovery, other interventions can be more e¢ cient, and whether the debt reduction is done by the government or by lenders matters for its e¢ cacy and desirability. Hence, while the intuitive appeal We bene…tted from the helpful comments of Andy Abel, Gene Amromin, Philip Bond, Zhiguo He, and David Romer.