Costly default and skewed business cycle

Patrick Fève, Pablo Garcia Sanchez, Alban Moura and Olivier Pierrard

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Abstract: We augment a simple Real Business Cycle model with financial intermediaries that may default on their liabilities and a financial friction generating social costs of default. We derive a closed-form solution for the general equilibrium of the economy, providing analytical results. Endogenous default generates a negative skew for aggregate variables and a positive skew for credit spreads, as documented in the empirical literature. Larger financial frictions strengthen asymmetry, which amplifies the welfare cost of fluctuations. Macro-prudential regulation alleviates both the cost of fluctuations and business-cycle asymmetry, at the expense of a steady-state distortion. Finally, we prove analytically the existence of an optimal level of regulation, which increases with the size of the financial friction.

Keywords: Real Business Cycle model; Default; Financial frictions; Asymmetry; Optimal regulation (search for similar items in EconPapers)
Date: 2021-02
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-fdg, nep-isf and nep-mac
Note: View the original document on HAL open archive server: https://hal.science/hal-03346173v1
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Citations: View citations in EconPapers (4)

Published in European Economic Review, 2021, 132, ⟨10.1016/j.euroecorev.2020.103630⟩

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Related works:
Journal Article: Costly default and skewed business cycles (2021)
Working Paper: Costly default and asymmetric real business cycles (2019)
Working Paper: Costly default and asymetric real business cycles (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03346173

DOI: 10.1016/j.euroecorev.2020.103630

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