In the standard model of labor supply based on intertemporal substitution, temporary wage increases expand both labor supply and assets. Hence, one might hypothesize that households repay debt when labor supply is high. Figure 1 examines this prediction with aggregate data and shows the opposite: Household debt (including mortgages and automobile loans) deflated by the chain-weighted price index for GDP and aggregate hours, both HP-filtered, display a clear and strong positive comovement.
Figure 1 suggests that the standard model of labor supply fails to characterize house holds’ use of financial markets over the business cycle. In this paper, we present a model that generates positive comovement between hours worked and household debt with occasionally-binding minimum down-payment requirements for purchases of durable goods. These motivate households to raise labor supply when increasing debt. We denote the resulting expansion of hours worked the financial labor supply accelerator. To assess its empirical credibility, we calibrate the model’s parameters and compare its predictions with observations of household choices from the Panel Study of Income Dynamics.
We find that the positive comovement of hours worked and debt manifests itself in within households across years even after controlling for household fixed effects and calendar-year effects. The calibrated model economy quantitatively reproduces this. In the data, the connection between the two variables weakens after the financial reforms of the 1980’s. An empirically realistic reduction of the model’s required down payments generates a quantitatively similar weakening.
The model embodies two salient features of most household debt in the U.S.: durable goods serve as collateral, and new borrowing requires a minimum down payment. When the minimum down-payment constraint binds, a persistent wage increase generates a shortage of funds to finance the desired durable goods purchases. In the financial accelerator models of Bernanke and Gertler (1989); Kiyotaki and Moore (1997); Bernanke, Gertler, and Gilchrist (1999); credit-market imperfections amplify the fluctuations of borrowing-constrained firms’ demand for factors of production.
Unlike with firms, a shortage of household funds expands economic activity. Nevertheless, the traditional financial accelerator and that we consider here can complement one another. A persistent technology shock that increases firms’ earnings and thereby triggers the traditional financial accelerator, should also raise wages. Then, the financial labor supply accelerator ensures that a given wage increase brings forth more hours worked. This labor supply response further raises output and strengthens the traditional financial accelerator by generating even more earnings for borrowing constrained firms.
