Firm leverage, household leverage and the business cycle

Bernard Daniel Solomon

MPRA Paper from University Library of Munich, Germany

Abstract: This paper develops a macroeconomic model of the interaction between consumer debt and firm debt over the business cycle. I incorporate interest rate spreads generated by firm and household loan default risk into a real business cycle model. I estimate the model on US aggregate data. This allows me to analyse the quantitative importance of possible feedback effects between the debt levels of firms and households, and the relative contributions of financial and supply shocks to economic fluctuations. While firm level credit market frictions significantly amplify the response of investment to shocks, they do not amplify output responses. In general equilibrium, higher external financing spreads for households contribute to lower external financing spreads for firms, contrary to traditional Keynesian predictions. Furthermore, total factor productivity shocks remain an important source of business cycles in my model. They are responsible for 71 - 74% of the variance of output and 56 - 69% of the variance of consumption in the model. Financial shocks are important in explaining interest rate spreads and leverage ratios, but they account for less than 11% of the fluctuations in output. My results suggest that other factors, beyond credit market frictions on their own, are necessary to justify an important role for financial shocks in aggregate output fluctuations.

Keywords: Financial frictions; external finance premium; DSGE models; Bayesian estimation; business cycles (search for similar items in EconPapers)
JEL-codes: C11 E21 E32 E43 E44 (search for similar items in EconPapers)
Date: 2010-10-30
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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