Income stagnation, debt overhang, and household liquidity constraints in China

ABSTRACT

This paper studies the causes of household liquidity constraints in China, the inhibiting impact of liquidity constraints on aggregate demand, and the amplifying effect of liquidity constraints on the negative impact of the COVID-19 pandemic. Using the China family panel studies (CFPS) 2010-2018 and Internet survey data during the pandemic, we analyze the impact of the "income effect" caused by income decline and the "debt overhang effect" caused by real estate boom on household liquidity constraints. Furthermore, we also explore the amplifying effect of liquidity constraints on negative demand shocks during the pandemic. We find that, liquidity of Chinese households had been gradually deteriorating before the pandemic, specially, from 2010 to 2018, the ratio of China's households who were subject to liquidity constraint was increasing from 24.37% to 35.31%. For the middle-income class, compared with the "income effect", the "debt overhang effect" is more significant, and is the main driver of making households possibly subject to liquidity constraints. Meanwhile, liquidity constraints significantly affect consumption, compared with households without liquidity constraints, households with liquidity constraints decrease their consumption by 6.9%. To the amplifying effect of liquidity constraints on the impact of pandemic, we find that, compared with homeowners without mortgage, homeowners with mortgage and households without housing both reduced more consumption, saved more, are also more likely to fall into liquidity constraints, and more conservative on consumption in the second half of 2020. This paper not only provides a new explanation for the sluggish consumption in China, but also provides a basis for demand-side reform. © 2022, Editorial Board of Journal of Systems Engineering Society of China. All right reserved.