Essays on the interaction between financial constraints and households

This thesis aims to advance our understanding of how credit markets, and credit market frictions, affect households. In particular, it considers how different credit conditions, driven by economic activity, financial sector activity or by government policy, can affect households’ financial constraints and ultimately, household debt and consumption dynamics. The first chapter is mainly theoretical. The second and third chapters are empirical. The first chapter builds a DSGE model with financial frictions and macroprudential tools, such as capital requirements on banks, and loan-to-value (LTV) limits and debt service ratio (DSR) limits on household finance. It then examines how different macroprudential tools: i) affect the response of key macro aggregates to aggregate economic shocks; ii) interact with each other and with monetary policy; and iii) affect household welfare. It finds that capital requirements can reduce the effects of financial shocks on the real economy. LTV limits on household finance are not sufficient, on their own, to constrain household indebtedness in booms, though can be used with capital requirements to keep households’ debt-service ratios under control. Finally, DSR limits lead to a decrease in the volatility of inflation, and are thus welfare improving relative to any other macroprudential tool. In the second chapter, I use matched microdata for the UK to estimate two distinct channels via which credit supply shocks affect household mortgage debt: one that operates through price conditions in credit markets; and another that operates through non-price credit conditions and affects the quantity of household credit supplied by lenders. I find substantial heterogeneity in the different channels by age, financial situation, borrower type and income. For instance, young households and home-owners respond exclusively to non-price credit conditions, while first-time buyers, middle-income households and middle-aged borrowers increase debt following shocks to either type of credit conditions. In aggregate, household leverage responds more strongly to supply shocks that change the quantity of credit, as they affect households across the distribution, both at the intensive and at the extensive margin. But a loosening in price and non-price credit conditions simultaneously or a contraction in multiple price indicators at a time can also fuel rapid credit growth. The third chapter uses UK transaction-level data to examine who accessed mortgage payment holidays (PH) during the Covid-19 crisis and how this government policy affected household consumption and debt behaviour. It finds that mortgage PH were used by households with pre-existing financial vulnerabilities and by buy-to-let investors. Households used the additional liquidity from mortgage PH to smooth consumption and to rebuild their balance sheets in 2020. In particular, among liquidity-constrained households, those on mortgage PH had substantially higher annual consumption growth and credit card repayments compared to those non-eligible for the policy. Among more financially stable households, mortgage PH led to higher saving rates and personal loan repayments.