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The Debt-Payment-to-Income Ratio as an Indicator of Borrowing Constraints: Evidence from Two Household Surveys

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Abstract:

Liquidity constraints have been proposed as an important explanation for deviations from the rational expectations/permanent income hypothesis. This paper introduces to the liquidity constraint literature the ratio of a household's debt payments to its disposable personal income, the debt service ratio (DSR). We find that a household with a high DSR is significantly more likely to be turned down for credit than other households. Also, the consumption growth of likely constrained households, identified using the DSR along with the liquid-asset-to-income ratio, is significantly more sensitive to past income than that of other households, confirming the DSR's value in identifying constrained households.

Keywords: E21; borrowing constraints; consumption smoothing; debt service ratio

Document Type: Research Article

DOI: http://dx.doi.org/10.1111/j.1538-4616.2010.00345.x

Affiliations: 1: Kathleen W. Johnsonis a Senior Economist at the Division of Research and Statistics, Board of Governors of the Federal Reserve System (: )., Email: Kathleen.W.Johnson@frb.gov 2: Geng Liis an Economist at the Division of Research and Statistics, Board of Governors of the Federal Reserve System (: )., Email: Geng.Li@frb.gov

Publication date: October 1, 2010

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