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Debt and Persistence of Financial Shocks

Project description

A closer look at the lingering impact of household debt

In the wake of the 2007 banking crisis and the ensuing economic recession, the United States and Europe experienced a profound shock that left deep scars on their economies. The aftermath of financial crises is known to trigger more severe and enduring contractions in output and employment compared to non-financial recessions. The persistently puzzling question remains: Why are the effects of credit shocks so long-lasting? To find the answer, the ERC-funded PERSISTDEBT project will construct comprehensive datasets by merging information from various sources, including exhaustive credit information. This approach allows researchers to obtain causal evidence and precise quantification on the intricate interplay between debt, systemic risk, crises, and novel macroprudential policies.

Objective

In 2007 the US and Europe were overwhelmed by a banking crisis, which was followed by a severe economic recession. Historical studies show that financial crises are followed by periods of substantially stronger contraction of aggregate output and employment than non-financial recessions. Those studies also point out that the best predictor of financial crises is an ex-ante strong credit boom which, after the beginning of the crisis, followed by negative overall credit growth. Lastly, financial crises take a long time until recovering the pre-crisis levels.
Why are the effects of credit shocks so strong and persistent over time? Is this effect explained by costly household deleveraging? What is the effect of household debt on consumption, savings and employment? Are there any benefits of debt in crises? Do some effects of the financial crisis work through a reduction in credit supply to firms and projects with high innovative content and productivity (high overall return, but with high credit and liquidity risk for the lenders)? Or are the cleansing effects in financial crises concentrated on the less productive firms? Can macroprudential policies based on strict control of loan-to-value ratios stop the building up of excessive household debt?
We plan to construct several new datasets to study these issues by merging information from different sources. For some issues, like the analysis of the effect of household debt on consumption and employment, we can take advantage of a natural experiment of randomized allocation of debt among individuals derived from the use of lotteries to allocate the rights to buy housing in Spain. In comparison to the existing literature, we can exploit the exogenous variation generated by these lotteries and some other combination of data (including exhaustive credit data) to obtain causal evidence and quantification on the interaction between debt, systemic risk, crises, and the new macroprudential policy.

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Topic(s)

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Funding Scheme

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ERC-COG - Consolidator Grant

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Call for proposal

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(opens in new window) ERC-2014-CoG

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Host institution

UNIVERSIDAD POMPEU FABRA
Net EU contribution

Net EU financial contribution. The sum of money that the participant receives, deducted by the EU contribution to its linked third party. It considers the distribution of the EU financial contribution between direct beneficiaries of the project and other types of participants, like third-party participants.

€ 1 208 676,00
Address
PLACA DE LA MERCE, 10-12
08002 Barcelona
Spain

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Region
Este Cataluña Barcelona
Activity type
Higher or Secondary Education Establishments
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Total cost

The total costs incurred by this organisation to participate in the project, including direct and indirect costs. This amount is a subset of the overall project budget.

€ 1 208 676,00

Beneficiaries (2)

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