Bjørn H. Vatne1

Norges Bank Financial Stability

HOUSEHOLD EXTERNAL FINANCE AND CONSUMPTIONTimothy J. Besley, London School of Economics (LSE) and CEPRNeil Meads, Bank of EnglandPaolo Surico, Bank of England

Comments from a practitioner: Bjørn H. Vatne, Financial Stability, Norges Bank

Norges Bank Financial Stability

Bjørn H. Vatne 2

• Hypothesis:– terms on which households access to external finance matters for consumption

• Method:– a theoretical motivation for a risk premium for risky borrowers– define first time buyers with little collateral as risky borrowers– estimate what premium these borrowers are asked to pay in the mortgage market – construct an HEF-index based on the spread paid by risky borrowers from

mortgage data– analyse the correlation between consumption growth and HEF-index with

regressions• aggregate and cohort levels

• Conclusion– the index is robustly correlated with consumption growth between 1975 and 2005

HOUSEHOLD EXTERNAL FINANCE AND CONSUMPTION

Norges Bank Financial Stability

Bjørn H. Vatne 3

The analysis relies on two critical points

1 The index captures the important changes in the terms that the households faces in the credit market

2 There is a causality between the conditions in the credit marked (index) and household consumption

Norges Bank Financial Stability

Bjørn H. Vatne 4

Which factors affect credit risk in households?

BANKS• Probability of default:

margin = income – tax – basic living expenses – (interest rate + repayment rate)*loan– negative margin: debt at risk

• Loss given default: Loan/value

• Bank decision:Loan/ no loans

• probability of defaultSize of loan and interest

• loss given default• Are young first time buyers risky?

HOUSEHOLDS• Margin can be used to consumption and non repayment savings• Consumption depends on the saving rate of all households• How the interest rates of risky households affect the consumption of other

households?– trough house prices?

Norges Bank Financial Stability

Bjørn H. Vatne 5

It would be interesting to know…

• how the HEF index relate to other indictors of credit rationing?– Credit Conditions Surveys– Loan to income, Loan to value indicators

• how changes in the economy affect the HEF index– bank stress– house prises– uemployment

Norges Bank Financial Stability

Bjørn H. Vatne 6

Do the HEF-index predict consumption falls?

• We would expect a delay between credit rationing and consumption fall?

• Causality tests?

• Or is there an underlying factor (economic expectations) that drives both series?

Norges Bank Financial Stability

Bjørn H. Vatne 7

Summing up

• Understanding the connection between terms in the credit market and consumption is important to– monetary policy and financial stability– understand financial accelerators

• Access to timely micro data is necessary to identify the groups of households that drives the dynamics

• A suggestion– credit terms of first home buyers – house prices– house prices – saving rate of home owners – households with small margins – credit risk households– consumption – credit risk firms