HOUSEHOLD LEVERAGE AND SOVEREIGN RISK

Comments

Juan F. Jimeno (Research Division)

CONFERENCE: “Debt and Credit, Growth and Crises”

Madrid

18-19 June 2012

RESEARCH DIVISION

THE PAPER (I)

• Main objective

• Explanation of cross-country GDP and employment growth in the Eurozone (EZ) during the crisis

• Using the US experience as a starting point (Mian and Sufi, 2010, Midrigan and Philippon, 2010)

• In the EZ: A two-stage story of the crisis (Two stages ?):

• 2007-2010: Deleveraging in the private sector• 2010-?: Fiscal consolidation and sovereign crisis

• Cross-country differences in household leverage and financing costs to Governments, respectively, can explain cross-country differences in GDP, consumption, and employment growth in 2007-2009 and 2010-2011.

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THE PAPER (II)

• Method•Calibration of DSGE model with credit frictions (still preliminary)

• “Islands” with representative consumers• Cash-in-advance-constraint with two sources of “money”• Two sectors (tradables, non-tradables) with sector-specific labor • Sticky wages• Intertemporal substitution modeled as adjustment costs to asset holdings• Government and private lenders are perfect substitutes. No monetary policy (M=1). Fiscal transfers providing money.

• Extension (and simplification) of Midrigan and Philippon (2010) to account for fiscal policy •Two exogenous shocks:

• collateral constraint to private credit• financing costs of Governments

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MAIN QUESTION

• Do the model’s assumptions fit well with the European experience to be explained?

• Empirical evidence on the credit-consumption channel

• The different nature of the crisis across EZ countries

• Asymmetries and imbalances in the EZ

• Credit boom, deleveraging and sovereign risk premia

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COMMENT #1: RELATIONSHIP BETWEEN CREDIT AND CONSUMPTION IN EUROPE

Alberola, Molina and del Rio (2012)

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COMMENT #1: RELATIONSHIP BETWEEN CREDIT AND CONSUMPTION IN EUROPE

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1. The role of housing as a source of liquidity

• UK : Increases in housing prices led to more borrowing

Bridges, Disney and Gathergood (2009).

• DK: Introduction of home equity loans led to increases in consumption.

Leth-Petersen (2010)

• Less evidence for other economies, as equity withdrawal less intense

SP: Bover (2005): Estimation of wealth effects. Not very large.

Marques and Nieto (2003): Mortgage refinancing did not increase as a result of

higher house prices. (Update: only in 2005 increase in mortgage debt > increase

in housing investment)

2. But even without home equity withdrawals, mortgage credit conditions may affect

household consumption (SP: Masier and Villanueva, 2011).

• Longer mortgage maturity partly allows to diminish the mortgage payment and increase

consumption by recent home owners

• Specially important if expect income to be higher later in life

3. On the downside: Are households/firms credit-constrained?

• Disentangling demand-supply of credit

SP: Hernando and Villanueva (2012): “relatively small magnitude of credit supply factors”

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Table 2: OLS impacts of interest rates and maturity on non-durable consumptionImpact of a 100 bp Impact of a one year Income growth

increase in R increase in M 50-65 yearsPanel A: Average impact (1) (2) (3)1.Total effect -.0335 .0133

(.0180)* (.0069)**Panel C: By schooling of hhold head

2. Basic schooling .0216 .016 -.126(.026) (.011) (.071)*

3. High school .023 .029 -.099(.032) (.010)** (.077)

4. College -.11 .007 -.14(.026)** (.008) (.08)*

Estimation method: group -specific OLS. Robust standard errors in parentheses.Sample of home owners observed in 2002/2005 who acquired their house with a mortgage between 1991 and 2006.

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Table 3: The impact of R and M on non-durable consumption

Impact of a 100 bp Impact of a one year Sample increase in R increase in M size

(1) (2)Panel B: By income group2. Below median income .0046 -.003 454.2

(.042) (.014)

3. 50th< Y < 75th centile -.028 .025 615.2(.035) (.012)**

4. Top income quartile -.066 .013 785.4(.039)* (.01)

Estimation method: group -specific OLS. Robust standard errors in parentheses.Sample of home owners observed in 2002/2005 who acquired a mortgage in 1992-2006.Other Xs: permanent income, age at purchase, year of purchase, revaluation of house value, family sizesavings bank dummy, 4 dummies with current age of spouse

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LEVERAGE AS DRIVING CONSUMPTION: EVIDENCE FOR SPAIN

• Spanish Survey of Household Finances, (EFF 2002, 2005, 2008)

• A panel that allows tracking the consumption, labor supply, wealth and debt of households

• The evolution of household expenditure in vehicles between 2002 and 2008 by the leverage ratio in 2002

• Some evidence of higher cyclicality of the expenditure in durables among indebted households

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MAIN QUESTION

• Do the model’s assumptions fit well with the European experience to be explained?

• Empirical evidence on the credit-consumption channel

• SOME EMPIRICAL SUPPORT. LIKELY TO BE RELEVANT. BUT PROBABLY LESS STRONG THAN IN THE US

• The different nature of the crisis across EZ countries

• Asymmetries and imbalances in the EZ

• Credit boom, deleveraging and sovereign risk premia

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Employment growth (%) vs. GDP growth (2007q2-2010q2)

GDP

COMMENT #2. SAME SHOCK? SAME (LABOR MARKET) TRANSMISSION MECHANISMS?

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Employment growth (%) vs. GDP growth (20010q2-2011q4)

GDP

COMMENT #2. SAME SHOCK? SAME (LABOR MARKET) TRANSMISSION MECHANISMS?

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MAIN QUESTION

• Do the model’s assumptions fit well with the European experience to be explained?

• Empirical evidence on the credit-consumption channel

• The different nature of the crisis across EZ countries• DIFFERENT SHOCKS. • DIFFERENT LABOR MARKET RESPONSES DIFFICULT TO EXPLAIN WITH SAME DEGREE OF LABOR MARKET RIGIDITIES ACROSS COUNTRIES

• Asymmetries and imbalances in the EZ

• Credit boom, deleveraging and sovereign risk premia

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COMMENT #3. ASYMMETRIES AND IMBALANCES

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• Lower productivity growth in the periphery during 1999-2007…• … and higher wage pressure, led to

Alberola, Molina and del Rio (2012)

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COMMENT #3. ASYMMETRIES AND IMBALANCES

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• …and together with lax fiscal policies to

Alberola, Molina and del Rio (2012)

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COMMENT #3. ASYMMETRIES AND IMBALANCES

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• but could have a more restrictive fiscal policy avoided the increase in external debt?

Gavilán, Jimeno, Hernandez de Cos, and Rojas (2010)

Assume government consumption would have stayed constant, in per capita terms, at its 19981s level for 10 years

(Scenario #1) or 20 years (Scenario #2). Beyond 2008 in Scenario #1, 2018 in Scenario #2, government consumption

represents again a 17:3% of GDP in each period.

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MAIN QUESTION

• Do the model’s assumptions fit well with the European experience to be explained?

• Empirical evidence on the credit-consumption channel

• The different nature of the crisis across EZ countries

• Asymmetries and imbalances in the EZ

• COMPETITIVENESS, EXTERNAL IMBALANCES ARE KEY TO UNDERSTAND EZ CRISIS

• Credit boom, deleveraging and sovereign risk premia

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COMMENT #4. SOURCES OF SHOCKS

• Endogenous leverage

• The role of banks (and shadow banking) at generating credit cycles

• Nuño and Thomas (2012)• Martinez-Miera and Suarez (2012)

• Factors behind the financing cost of EZ Governments ?

• Only fiscal variables?• Contagion effects? • Interactions public-private sectors?• Other variables?

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FINANCING COST OF GOVERNMENTS

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Spain: 10y bond yield

July 7th: 4.71 %July 11th: Spain wins FIFA World

CupAugust 27th: 3.98 %October 14th: 3.92%

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THANKS FOR YOUR ATTENTION ¡¡¡

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