Household Liquidity Constraints and Labor Market Outcomes: Evidence from a Danish Mortgage Reform

Abstract

This paper studies the effects of household liquidity constraints on individual labor market outcomes by exploiting a mortgage reform in Denmark in 1992, which for the first time allowed homeowners to borrow against housing equity for non-housing purposes. We find that following the reform, liquidity-constrained homeowners extracted housing equity, increased debt levels, and had higher earnings growth and lower employment rates. In contrast, the reform had small and opposite effects on the earnings and employment rates of homeowners with high liquid asset holdings. Consistent with models of job search with risk aversion, the option to borrow against housing equity allows liquidity-constrained individuals to search for high-wage jobs. The results imply that relaxing household liquidity constraints during recessions could potentially increase earnings and output in the longer run through labor market search.

JEL Classification: G21, E44, E24, J60, D14, R20