Conditional effect of government debt on household debt

ABSTRACT

How does government debt affect household debt? Capitalizing on a model of life-cycle economy populated by households with no bequest motive, this article shows that effect of government debt on aggregate household debt is conditional. If residence-service benefit of house is greater than equity-accrual benefit of house investment, government debt negatively affects household debt. If not, government debt positively affects household debt. This theoretical finding is tested with panel data of 53 countries over 1991–2019. Using system Generalized Method of Moments finds supportive evidence for the conditional effect, which remains robust after adopting external instrumental variable and alternative approach to expectation formation.

KEYWORDS:

• Government debt
• household debt
• home equity
• consumption smoothing

JEL CLASSIFICATION:

• G51
• E62
• H63

Disclosure statement

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

Notes

¹ In this study, tax refers to payment from individual households to the government after netting out any benefits from transfer programs of the government.

² For properly testing Proposition 1, the data sample is split by the condition of ${\alpha }_t-\frac{\left(1+r_{\dot{t}}^m\right)m_t}{2}$, instead of using interaction term between government debt and the indicator of the sign of ${\alpha }_t-\frac{\left(1+r_{\dot{t}}^m\right)m_t}{2}>0$ with combined data. Notice that the interaction term fails to test Proposition 1 because the interaction term estimates only the margin of the change in the magnitude of the effect of government debt on aggregate household debt. That is, the coefficient of the interaction term cannot indicate the switch of the effect from being negative to positive.