Household Debt and Business Cycles Worldwide

An increase in the household debt to GDP ratio in the medium run predicts lower subsequent GDP growth, higher unemployment, and negative growth forecasting errors in a panel of 30 countries from 1960 to 2012. Consistent with the “credit supply hypothesis,” we show that low mortgage spreads predict an increase in the household debt to GDP ratio and a decline in subsequent GDP growth when used as an instrument. The negative relation between the change in household debt to GDP and subsequent output growth is stronger for countries that face stricter monetary policy constraints as measured by a less flexible exchange rate regime, proximity to the zero lower bound, or more external borrowing. A rise in the household debt to GDP ratio is contemporaneously associated with a consumption boom followed by a reversal in the trade deficit as imports collapse. We also uncover a global household debt cycle that partly predicts the severity of the global growth slowdown after 2007. Countries with a household debt cycle more correlated with the global household debt cycle experience a sharper decline in growth after an increase in domestic household debt.