Navigating the Waves: A Study on the Effect of Income Volatility on Household Debt Accumulation

Abstract: This study investigates the influence of income volatility on household borrowing behavior, contributing to the broader discussion on the relationship between inequality and the risk of financial crises. While prior studies have generally focused on permanent income inequality, we address the overlooked aspect of transitory income inequality. We use data from the Panel Study of Income Dynamics to calculate the inherent individual earnings volatility of different industries, which is used to represent the income volatility faced by households. By adopting a difference-in-differences methodology, we compare the debt accumulation of households with high and low income volatility during the years preceding the 2008 crisis, against the backdrop of the Gramm-Leach-Bliley Act. The results are inconclusive. We attribute this to possible methodological limitations. Nevertheless, this study contributes to the literature by shedding light on an underexplored dimension of income inequality and its potential impact on credit growth. We call for further research to refine the methodology and to provide more definitive insights into the link between income volatility and household borrowing behavior.