Financial leverage interactions: evidence from US households and government sectors

ABSTRACT

Applying VAR/SVAR analysis to the national balance sheet data of the US, this paper provides evidence that the households markedly interact with those of government sectors through the channel of financial leverage, which is defined as the liabilities-to-assets ratio. In particular, the impulse-response and forecasting error decomposition analysis further show that the federal government plays an important role in absorbing the leverage shocks in households. Nevertheless, it should be emphasized that this role of the federal government as somewhat of a macroeconomic stabilizer also costs it heavily in view of its escalating leverage over time. Among other concerns, this highly leveraged financial position renders the federal balance sheet more vulnerable to macro-financial risks, thus reducing the room for manoeuvre for countercyclical policies. Finally, with a relatively low and stable leverage ratio, the state/local governments seem to be less involved in such interactions. However, their prudent balance sheet position also implies that they play a minor role in fiscal measures supporting households during economic downturns.

KEYWORDS:

• Financial leverage
• balance sheet
• vector autoregression
• business cycles

JEL CLASSIFICATION:

• E32
• H50

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ It is noteworthy that as of the end of 2020, the US households’ financial leverage appears to be largely unaffected by the outbreak of the Covid-19 pandemic.

² The coefficients of the two exogenous variables, unreported due to space limitations, are jointly significant in all equations.