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Center for Financial Research

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Abstract. Over the past fifteen years, U.S. households have committed a rising share of their disposable personal income to required principal and interest payments on household debt such as mortgages, automobile loans and credit card balances. This rise in the household debt service ratio (DSR) has generated interest of late because it could potentially cause households to cut back on their spending. This direct link between household debt and consumption has been studied in the literature, but the results of these studies are mixed—perhaps because debt may not have a direct effect on consumption growth, but rather may alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households in the Consumer Expenditure Survey over the DSR distribution. Our approach has two advantages relative to the existing literature. First, it avoids the most obvious source of endogeneity between debt and spending by studying the indirect effect of the DSR on the ability to smooth consumption through income fluctuations. Second, this approach is to our knowledge the first serious look at household-level DSRs, which vary substantially both across time and households. Our results indicate that households with relatively high DSRs are no less able to smooth through income fluctuations than other households. Rather, households with low or zero DSRs appear least able to smooth. This finding suggests that recent rises in the aggregate DSR could be welfare-enhancing to the extent they were the result of increased credit access to low-income households documented elsewhere.

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