We examine the consequences of a sudden increase in household debt burdens by exploiting variation in exposure to household foreign currency debt during Hungary’s late-2008 currency crisis. The revaluation of debt burdens causes higher default rates and a collapse in spending. These responses lead to a worse local recession, driven by a decline in local demand, and negative spillover effects on nearby borrowers without foreign currency debt. The estimates translate into an output multiplier on higher debt service of 1.67. The impact of debt revaluation is particularly severe when foreign currency debt is concentrated on household, rather than firm, balance sheets.

This paper studies how a large increase in the price level is transmitted to the real economy through firm balance sheets. Using newly digitized macro- and micro-level data from the German inflation of 1919–1923, we show inflation led to a large reduction in real debt burdens and bankruptcies. Firms with higher nominal liabilities at the onset of inflation experienced a larger decline in interest expenses, a relative increase in their equity values, and higher employment during the inflation. The results are consistent with real effects of a debt-inflation channel that operates even when prices and wages are flexible.