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Constant Consumption Smoothing, Limited Investments, and Few Repayments: The Role of Debt in the Financial Lives of Economically Vulnerable Families

University of Michigan

American households increasingly carry debt. Taking on debt can increase consumption beyond what one’s income can support, it can smooth consumption during periods when income falls, and it can represent an investment in the future. I find that economically vulnerable households take on debt primarily for purposes of consumption smoothing and investment in the future but that, over time, having debt can result in significant financial challenges. Consumption smoothing can be ongoing, entailing taking on additional debt or impeding the payment of existing debt. Investments families make in the future via educational loans and home purchases may not pay off. Carrying debt raises the possibility that wages or income tax refunds will be garnished, disrupting families’ financial lives and negatively affecting their well-being. Finally, most families do not perceive clearing debt through bankruptcy as an option, and the ones who do are not left much better off financially following bankruptcy.