Learning Financial Shocks and the Great Recession

Jacek Suda and Patrick Pintus

No 577, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning their uncertain environment. When agents update their beliefs about the parameters that govern the unobserved process driving financial shocks to the leverage ratio, the responses of output and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with actual leverage innovations observed over that period, the learning model predicts a sizeable recession in 2008-10, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the amplification due to learning and, accordingly, that macro-prudential policies enforcing countercyclical leverage dampen the effects of leverage shocks.

Date: 2015
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
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Citations: View citations in EconPapers (13)

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Related works:
Journal Article: Learning Financial Shocks and the Great Recession (2019)
Working Paper: Learning Financial Shocks and the Great Recession (2019)
Working Paper: Learning Financial Shocks and the Great Recession (2018)
Working Paper: Learning Financial Shocks and the Great Recession (2016)
Working Paper: Learning Financial Shocks and the Great Recession (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:577

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