Debt and financial expectations: an individual and household level analysis

In this paper we show that optimistic financial expectations impact positively on both the quantity of debt and the growth in debt, at the individual and household levels. Our theoretical model shows that this association is predicted under a variety of plausible scenarios. In the empirical analysis we explore the determinants of debt and of growth in debt using British data. We find convincing support for our theoretical priors and show that it is optimistic financial expectations per se that are important in influencing debt, rather than the accuracy of individuals’ predictions regarding their future financial situation.