Household debt and macroeconomic stability: An empirical stock‐flow consistent model for the Danish economy

This paper addresses the issue of household debt in the Danish economy. We develop a large‐scale stock‐flow consistent model. The model has five main sectors namely, household, firms, financial corporations, government, and the rest of the world sectors. We use the model to explore the macroeconomic stability of the Danish economy, given the recent level of household debt. We fit the model to annual data from 1998 to 2016, estimate the structural parameters, and simulate the model for a baseline scenario, against which we compare and contrast the effects of different economic shocks. To assess the macroeconomic risks associated with high household debt, we introduce two shocks separately—a fall in house prices and a rise in interest rates—finding that these shocks have adverse effects on the economy. Focusing on macroeconomic stability, we find that private domestic demand seems to be relatively sensitive to the changes in interest rates and house prices, but the overall output is less affected, mainly due to strong current account surplus. Overall, it can be concluded that in the absence of global shocks, domestic shocks to the economy may not pose a serious risk to macroeconomic stability, when purely focusing on the sensitivity of output growth and unemployment.