Income Risk and Household Debt with Endogenous Collateral Constraints

We investigate possible determinants of the increase of household debt and smaller consumption fluctuations since the 1980s in the US. We use a heterogeneous-agent model, in which labor income is risky and markets are incomplete. Consumers use durables not only as collateral for their debt but also derive utility from their durable stock. We first assume that all debt is secured. That is, debt is collateralized by durable holdings and the lowest attainable labor income flow. We show that financial-market development in terms of lower interest spreads (and lower borrowing rates) or laxer collateral constraints can explain the increase in household debt and lower volatility of durable expenditure but only imply minor changes in the volatility of non-durable consumption. We then extend the model to unsecured debt, default and risk-sharing with competitive financial intermediaries