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Gerlach-Kristen, Petra
Merola, Rossana
Year of Publication: 
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Working Paper, The Economic and Social Research Institute (ESRI), Dublin 471
Since the onset of the financial crisis, consumption has fallen in many economies. This paper presents a small-scale DSGE model with occasionally binding credit constraints. Indebted households start facing credit constraints when the value of their main asset, which we assume to be housing, declines. As a response, they stop smoothing consumption and deleverage. We show that even households that only expect to face a credit constraint in the future deleverage. In an Irish dataset collected during the crisis, we reject the permanent income hypothesis for highly leveraged households and thus find evidence for a disruption in consumption smoothing. This effect suggests the presence of credit constraints.
occasionally binding credit constraint
housing collateral
Document Type: 
Working Paper

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