Household Debt and Economic Growth in Europe

We investigate the role and impact of household debt on the economic performance of the European economy during the double-dip recession of 2008-2013. We use a loan-level data set of millions of residential mortgages originated between 2000 and 2013 to calculate regional indicators of household debt and property prices. The detailed information allows us to construct a measure of interest rate mis-pricing during the housing boom that we use to identify the effect of a credit shock on household debt. Our analysis provides three main conclusions. First, in the period 2004-2006 the measure of credit shock was negative in most European regions which indicates that credit conditions were significantly relaxed relative to earlier years. Second, we find that regions in which household leverage increased more rapidly during the 2004-2006 period experienced a more severe decline in output and employment after 2008. These results are consistent with the view that an aggregate credit supply shock in Europe boosted household leverage and house prices. Third, we find that the credit shock had the largest effect on increasing leverage for the low-income and the middle-income households, although the change in leverage of the middle-income households represents a more powerful predictor of the decline in economic activity.