Household Debt Overhang and Transmission of Monetary Policy

Abstract

Monetary policy was used during the Great Recession to stimulate the U.S. economy, but were its effects dependent on prevailing levels of high household debt? In working paper 1806, PERC Professor Sarah Zubairy and coauthor Sami Alpanda study the role of household debt on the effectiveness of monetary policy shocks. Using a state-dependent time-series model, findings show that the effectiveness of monetary policy is reduced during periods of high household debt. A small-scale theoretical model on interest rate cuts and home-equity loans points to one possibility why this may occur- higher initial debt levels may slow down the increase in home equity extractions when policy rates are cut.