Higher household debt has been associated with lower future GDP growth across a broad set of 80 countries over the period from 1950 to 2016. Several institutional factors, such as flexible exchange rates, capital account openness, and higher financial development and inclusion, appear to mitigate this negative relationship between an increase in household debt and lower future GDP growth. Three mutually reinforcing mechanisms help explain this relationship. First, increases in household debt amplify the probability of future banking crises which significantly disrupt financial intermediation. Second, crash risk may be systematically neglected due to investors’ overoptimistic expectations associated with household debt booms. Third, debt overhang impairs household consumption when negative shocks hit.
How to Avoid Household Debt Overhang? An Analytical Framework and Analysis for India