Dynamics of debt accumulation: three essays in applied macroeconomics
De Stefani, Alessia
Debt and credit markets played a crucial role in recent economic history. This thesis is composed of three chapters, each of which explores some drivers of private and public debt accumulation throughout the past decade. The first two chapters are directly linked, and study some behavioural determinants of household debt accumulation in the United States in the run-up to the 2007-2008 financial crisis. The third chapter takes a different perspective, and focuses on the political economy of fiscal reforms. In the first chapter, I study whether the growth in US household debt ahead of the 2007-2008 financial crisis can be attributed to shifts in the distribution of personal income across the US population. The underlying theoretical mechanism is based on the idea that if individuals are concerned with status, rising income inequality within a given social group might lead its relatively poorer members to consume a larger proportion of their resources, due to a desire to emulate the consumption levels of richer individuals (Duesenberry ; Frank, Levine and Dijk ; Bertrand and Morse ). I test this hypothesis by exploiting state-level variation in top incomes over time, following the methodology proposed by Bertrand and Morse . The results I present in this chapter challenge the status-emulation theory of consumer behaviour during the 2000s credit boom. I show that, between 1996 and 2007, only low and-middle-income home-owners increased their expenditure and debt-to-income ratios as a response to an increase in income inequality in their state of residence. I also show that the growth in income inequality was strongly correlated with house prices growth, across US states and metropolitan areas. The positive correlation between inequality and household debt in the pre-crisis US might therefore be simply explained by the wealth and collateral effects experienced by low and middle-income home-owners living in areas where inequality was growing at the fastest rates. The lifting of credit constraints due to rising house prices have been a major driver of household debt accumulation ahead of the 2007-2008 financial crisis (Mian and Sufi ). However, this effect might have been coupled with a generalized optimistic belief that the growth in house prices was likely to continue in the future (Case, Shiller and Thompson ). The second chapter therefore tests whether consumers hold realistic expectations about the housing market, and whether this is a driver of their consumption and saving decisions. Using the Michigan Survey of Consumers, I show that American households have heterogeneous expectations about the future of house prices, which systematically depend upon household characteristics, as well as upon the history of past house price realizations in the local area of residence. I also analyze individual-level forecast errors to show that house price expectations are biased and inefficient. Changes in individual forecast errors are predictable from past house price realizations in the local area of residence: in particular, forecast errors are positively correlated with recent price trends, and tend to become overoptimistic in good times, and over-pessimistic in bad ones. The predictability of forecast errors from public information available at the time the forecast was made suggests a violation of full-information rational expectations theory. This systematic bias in house price expectations matters because consumers make financial decisions on the basis of their house price beliefs. By exploiting an exogenous shift in housing sentiment, I show that when individuals expect the value of their properties to rise, they borrow against the anticipated increase in home equity. The third and final chapter shifts the focus to the political drivers of public debt and deficits. Public debt crises often call for the intervention of international financial institutions, such as the International Monetary Fund (IMF). In this chapter, I introduce a new panel dataset on planned fiscal policy prescriptions included in all IMF loans between 2002 and 2012, and use it to study how domestic politics of recipient countries influence the content of IMF lending agreements. I show that IMF policy prescriptions depend strongly on domestic politics and that fiscal conditions are shaped by a political force often neglected in public choice literature: the threat of extra-parliamentary opposition, or civil unrest. Extra-parliamentary opposition (measured as a populations’ propensity to riot and demonstrate) significantly reduces the stringency of fiscal policy conditions attached to IMF loans. It also reduces the number of reforms in the realms of public employment and labor markets. These results suggest that fiscal policy has a strong political component even during circumstances when domestic politics are commonly assumed to cease to matter, as they do in IMF agreements. Also, they suggest that voting is not the only mechanism through which politics enters the technical realm of economic policy.