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Working Papers

August 2019, No. 19-13

Consumption in the Great Recession: The Financial Distress Channel

Kartik B. Athreya, Ryan Mather, José Mustre-del-Río and Juan M. Sanchez

During the Great Recession, the collapse of consumption across the US varied greatly but systematically with house-price declines. Our message is that household financial health matters for understanding this relationship. Two facts are essential for our finding: (1) the decline in house prices led to an increase in household financial distress (FD) prior to the decline in income during the recession, and (2) at the zip-code level, the prevalence of FD prior to the recession was positively correlated with house-price declines at the onset of the recession. We measure the power of the financial distress channel using a rich-estimated-dynamic model of FD. We find that these channels amplify the aggregate drop in consumption by 7% and 45%, respectively.

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