Household Debt Relief and the Debt Laffer Curve

Abstract
Debt relief programs are often implemented in debt crises to reduce financial distress and promote economic recovery. If debt overhang is severe, then debt relief can even benefit creditors by increasing repayment rates. This paper studies the impact of a large-scale household debt relief program in Hungary that reduced outstanding debt burdens by 20% for over 600,000 foreign currency housing loans. Using regression discontinuity and difference-in-differences research designs, we find that debt relief persistently lowered default rates, with the largest responses for heavily indebted borrowers. We present a new methodology to estimate the Debt Laffer Curve, which relates the net present value of debt to its face value. The estimated Debt Laffer Curve is hump-shaped, inverting for high levels of indebtedness. A structural model of household debt and default can quantitatively account for these patterns.