European Household Debt Research

Over the past two decades, household debt has experienced sustained and rapid growth in the main developed countries, driven by both housing boom and the fast-growing consumption, and also accompanied with the process of the financial system increasing leverage and the hollowing out of the real economy. It is argued that an enormous burden of household debt has set the seed for the recent bursting of great global credit bubble and even the outbreak of European sovereign debt crisis.Therefore, profound research on the determinants, macroeconomic effects of household debt, as well as the logical link between debt overhang and the recent crisis process, is crucial to further understand the role of household debt in the business cycle. In addition, in consumption-oriented economies like the U.S., household debt has a great influence on consumption and therefore often leads to macroeconomic fluctuations, while in investment oriented economies like China, NFC (non-financial corporation) debt plays a more important role. However, along with China’s economic transition from investment oriented to consumption oriented, it is predictable that household debt ratio will increase gradually in the long run. As a result, research on household debt helps to better understand China’s economic trends and potential risks. With an abundance of sample countries in Europe, research on household debt in European countries will provide insightful views.This paper first analyzes in detail how debt and leverage have evolved in the household sector in most European countries on major European countries since 1995, including a comparison between "old European countries" and "new European countries". Then this paper provides a detailed analyze of the determinants of household debt based on the LC-PIH (life cycle/permanent income hypothesis) model, with the introduction of "borrowing constraint conditions". Next, it discusses the economic consequences of household debt and compares different government polices in time of household debt deleveraging. Finally, this paper analyzed the potential risks of Chinese household debt, and puts forward corresponding policy recommendations.The main conclusions are as follows:(1) based on a micro-level analysis of the core factors influencing household consumption and saving behaviors, it is found that the continuous household debt expansion in Europe since 1995 has been mainly driven by the low interest rates, housing boom, capital free flow and financial liberalization, which is also confirmed by empirical tests. (2) with a theoretical model, it is found that household debt firstly affects consumption, the aggregate demand and eventually income. The "multiplier-accelerator mechanism" leads to the self-reinforcing income increase driven by debt, but at the same time, deterioration of debtor’s cash flow with the increase of debt interests payments reduce the sustainability of income growth. An empirical model also verifies the positive effect of household debt and negative effect of interest payment. (4) it is found that countries with higher household debt burden will experience a larger drop in real GDP, real consumption expenditure, real retail sales and employment. Theoretical model is built, proving that debt deleveraging exacerbates the economic performance, even leading to deflationary spiral. (5) Finally, this paper proposes policy recommendations for China, including establishing and perfecting the household balance sheet statistics, improving the social credit system construction, ensuring the smooth and orderly development of the real estate market, etc.