The Implications of Household Debt on GDP and Private Consumption Growth in Estonia

Abstract

The relationship between household debt growth and economic growth has been the subject of debate. On one hand, it is generally viewed as a positive relationship. On the other hand, rapid growth of household debt could cause economic downturns. This research aims to (1) study the relationship between rising household-debt-to-GDP and the growth of real GDP and private consumption in the short run and medium run in Estonia and (2) analyze the role that institutional factors play in the relationship. The research uses the local projection model to trace impulse response functions for the path of GDP and consumption growth following a change in household debt ratio. Estonia’s data show that both the level and growth rate of household debt matter to its economic activities. The studied relationship between household debt and real GDP and private consumption in Estonia indicates that rising household debt is associated with higher private consumption and real GDP growth in the short run and slower economic activities in the medium run. Overall financial development and the depth of Estonia’s financial market and institution likely help reverse negative impacts of rising household debt on real GDP growth. Estonia could consider improving its financial institution efficiency to mitigate negative impacts of household debts on real GDP growth.