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The Impact on Consumption of the Household Indebtedness in Korea (EP Vol.13 No.1)

연구조정실 (02-759-5407) 2010.09.08 18288

The Impact on Consumption of the Household Indebtedness in Korea

Author : Hyun Jeong Kim and Wooyoung Kim

 This paper examines what impact the increasing indebtedness of the Korean households has had on consumption. For the analysis, the Korea Labor and Income Panel Study (KLIPS), which is a household panel data compiled every year since 1998, is used.   

 The estimation of consumption function using a panel data for the period of 2000~2007 shows that indebtedness has affected household consumption positively in Korea. This implies that the expansion of consumer credit has contributed to boosting consumption in the country by reducing the extent of liquidity constraint facing the households. Debt service ratio (DSR), on the other hand, has not exerted the expected negative influence on consumption, which seems to verify that low interest rates prevailing for the period have lessened the actual debt burden of the Korean households.   

  The role of debt with regard to household consumption, however, may have changed recently, as the estimation of consumption function using yearly data reveals that the coefficient of debt became negative in 2007 although its statistical significance is not high. To locate the sources for the change, we estimate the consumption function for the year with subsamples regrouped by income or by the ratio of financial asset to total asset held by each household. By income class, we still can identify the positive role of debt on consumption for the first or second income quintile. For the third income quintile, however, the coefficient of debt becomes negative, and that of DSR changes from positive to negative at a point where DSR increases to be 26% and higher. In addition, for the fourth or fifth income quintile who hold more than two thirds of total household debt in Korea, the coefficient of DSR is negative although it is not highly significant. Meanwhile, for the households whose ratio of financial asset to total asset is lower than the sample average, both debt and DSR have had significantly positive impact on consumption. Both variables, however, lose explanatory power in consumption function for the group with more-than-average ratio of financial asset to total asset.

 Based on the results, we can conclude that the role of debt in boosting consumption has been significant in Korea since 2000, and this is particularly so for the households with lower income or those holding less financial assets. Since 2007, however, indebtedness seems to start affecting negatively on household consumption in Korea, especially for the middle or high income groups. Such a negative impact of indebtedness on consumption may have been reinforced since 2008 due to economic recession with the household debt level still hovering high.

JEL Classification Number : D12, D14, E21

Keywords : Household Debt, Consumption, Life Cycle and Permanent Income Hypothesis, 
                  Korea Labor and Income Panel Study

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