From Scott Baker:
This paper exploits a new detailed household dataset with comprehensive financial information on millions of households to investigate the interaction between household balance sheets, income, and consumption during the Great Recession. In particular, I test whether consumption among households with higher levels of debt is more sensitive to a given change in income. I match households to their employers and use shocks originating from these employers to derive persistent and unanticipated changes in household income, finding that highly-indebted households are more sensitive to income fluctuations and that a one standard deviation increase in debt-to-asset ratios increases the elasticity of consumption by approximately 15-25%. I employ data regarding household savings and credit availability to show that these results are driven largely by borrowing constraints, especially the availability of liquid assets. These estimates suggest that the 2007-2009 recession was amplified by elevated levels of debt and illiquid assets, causing a fall in consumption approximately 25% greater than what would have been seen with the household balance sheet positions in 1983.