Debt dynamics and excess sensitivity of consumption to transitory wealth changes

Release date
01/10/2010
Reference
DP2010/09
Authors
Emmanuel De Veirman; Ashley Dunstan
Published as
De Veirman, Emmanuel and Ashley Dunstan (2012). ‘Debt dynamics and the relationship between consumption and cyclical wealth changes’, The Economic Record, Wiley, Volume 88(282), Pages 330-340, DOI: https://doi.org/10.1111/j.1475-4932.2012.00812.x.
We analyse the consumption-wealth relationship using a framework that accounts for transitory variation in wealth, and in a setting where transitory variation in household net worth is not dominated by boom and bust cycles in stock markets. We find that transitory variation in consumption depends positively on recent transitory changes in wealth. In addition, we find that gross asset wealth and household debt are positively related. Both findings constitute departures from standard lifecycle/ permanent income hypothesis theory with complete financial markets, but can be explained by the introduction of liquidity constraints.