Debt Overhang and Deleveraging in the US Household Sector: Gauging the Impact on Consumption

Using a novel data set for the U.S. states, this paper examines whether household debt and the protracted debt deleveraging help explain the dismal performance of U.S. consumption since 2007 in the aftermath of the housing bubble. By separating the concepts of deleveraging and debt overhanga flow and a stock effectwe find that excessive indebtedness exerted a meaningful drag on consumption over and beyond wealth and income effects. The overall effect, however, is modest-around one sixth of the slowdown in consumption between 2000-06 and 2007-12and mostly driven by states with particularly large imbalances in their household sector. This might be indicative of non-linearities, whereby indebtedness begins to bite only when misalignments from sustainable debt dynamics become excessive.