The drivers of household indebtedness reconsidered: An empirical evaluation of competing arguments on the macroeconomic determinants of household indebtedness in OECD countries

Abstract

Household debt is at a record high in most Organisation for Economic Co-operation and Development (OECD) countries and it played a crucial role in the recent financial crisis. Several arguments on the macroeconomic drivers of household debt have been put forward, and most have been empirically tested, albeit in isolation of each other. This article empirically tests 7 competing hypotheses on the macroeconomic determinants of household indebtedness together in one econometric study. Existing arguments suggest that residential house prices, upward movements in the prices of assets demanded by households, the income share of the top 1%, falling wages, the rolling back of the welfare state, the age structure of the population, and the short-term interest rate drive household indebtedness. We formulate these arguments as hypotheses and test them for a panel of 13 OECD countries over the period 1993–2011 using error correction models. We also investigate whether effects differ in boom and bust phases of the debt and house price cycles. The results show that the most robust macroeconomic determinant of household debt is real residential house prices, and that the phase of the debt and house price cycles plays a role in household debt accumulation.

Keywords:

• Household debt
• house prices
• cycles

JEL classification:

• E19
• E21
• R20

Notes

1 In Ryoo’s (2016) baseline model, the household sector is divided into worker and capitalist households. Workers have housing wealth, while capitalist households hold stocks. As capitalist households do not hold housing wealth, and as we are interested in highlighting channels through which household debt arises from house prices, we focus on Ryoo’s baseline model of worker households.

2 Top incomes have experienced a spectacular growth. For details, see the World Inequality Database http://wid.world/

3 Summaries of the empirical studies on the macroeconomic drivers of household indebtedness are provided in Table A1 in the Appendix.

4 In practice, testing the expenditure cascades hypothesis as a driver of household debt, and using the income share of the top 1% as a proxy for this hypothesis, is warranted if income growth and consumption growth are closely linked at the top. If the rich got richer, but don’t spend more, there would be no cascade. The empirical support for expenditure cascades is relatively recent, and the results are mixed (see, e.g., Christen and Morgan 2005; Leigh and Posso 2009; and Drechsel-Grau and Schmid 2014). That the results of the effects of expenditure cascades on household debt accumulation at present are also mixed and limited calls for further testing of the expenditure cascades hypothesis.

5 A comparison of the interest rates used in the studies is presented in Table A2 in the Appendix.