Economists have long recognized that investment-finance behavior can influence business cycles. For example, Minsky’s financial instability hypothesis proposes that debt dynamics contribute to macroeconomic instability (Minsky, 1980, 1986, 1992, 1995). The financial underpinnings of the recent recession has generated renewed attention to Minsky’s finance-driven endogenous business cycle model. In this paper, we focus on a related factor that has been little emphasized in most Minskyan models: the role of household debt.
Minsky (1992) himself suggested that the validation of household debt (along with government and international debt) can contribute to business cycle dynamics. Nevertheless, household debt played little role in his work, and most subsequent research has also largely neglected household debt. Recent events suggest that this neglect is missing an important cause of macroeconomic fluctuations. From the 1980s to the 2000s, the US experienced consumption expansion accompanied by significant household debt accumulation. Cynamon and Fazzari (2008) argue that this provided a substantial macroeconomic stimulus. These levels of debt accumulation eventually proved untenable—a fact that has been broadly implicated in the recent recession. This provides a core motivation for our present research.
Naturally we are not seeking to overturn the stylized fact that investment is more volatile than GDP and consumption, nor the central role of investment in economic fluctuations. Rather, this project explores the additional contribution of household expenditures and debt to macroeconomic fluctuations. Certain stylized facts suggest this contribution may be growing in importance. For example, the ratio of personal outlays to disposable personal income increased from about 88 percent in the early 1980s to nearly 100 percent in 2007. Additionally, household debt outstanding as a share of GDP increased from about 45 percent in 1975 to nearly 100 percent in 2006. The magnitude of these shifts is startling and calls for research on their implications.
This paper is organized as follows. Section 2 reviews some relevant literature. Sections 3–6 present and analyze a growth model with both consumer and corporate debt. Section 7 concludes.
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The Macrodynamics of Household Debt
