The Role of Collateralized Household Debt in Macroeconomic Stabilization

Market innovations following the financial reforms of the early 1980s drastically reduced equity requirements associated with collateralized household borrowing. This paper examines the contribution of this development to the macroeconomic stabilization that occurred shortly thereafter. The model combines collateralized household debt with heterogeneity of time preference in a calibrated general equilibrium setup. We use this framework to characterize the business cycle implications of lowering required down payments and rates of amortization for durable goods purchases as in the early 1980s. The model predicts that this reduction of equity requirements can explain a large fraction of the actual volatility decline in hours worked, output, household debt, and household durable goods purchases.