Do High Debt Payments Hinder Household Consumption Smoothing?

Abstract

Recently, U.S. households have committed a rising share of disposable personal income to required principal and interest payments on household debt. Studies of the direct link between the household debt service ratio (DSR) and consumption show mixed resultsâ perhaps because debt may instead alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households over the DSR distribution. We find that a high DSR alone does not indicate higher sensitivity of consumption to a change in income. However, we find evidence that the DSR may help identify borrowing constrained households. In particular, the consumption of households with low liquid assets and high DSRs is more sensitive than the consumption of other low liquid asset households. Although this effect of high DSR is not precisely estimated, it is large and robust to changes in the specification, suggesting that more work is warranted.

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