Household Leverage And The Recession
A salient feature of the recent U.S. recession is that output and employment have declined more in regions (states, counties) where household leverage had increased more during the credit boom. This pattern is difficult to explain with standard models of financing frictions. The authors propose a theory that can account for these cross-sectional facts. They study a cash-in-advance economy in which home equity borrowing, alongside public money, is used to conduct transactions. A decline in home equity borrowing tightens the cash-in-advance constraint, thus triggering a recession.