Financial Crisis Cycles

Keiichiro Kobayashi and Tomoyuki Nakajima

No 26-015E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: This paper develops a theoretical model of financial crisis cycles where credit-driven asset price booms are followed by busts and protracted recessions. The accumulation of private debt during booms generates a debt overhang that discourages borrowers from enhancing productivity in the post-crash period. When this debt burden is substantial, coordination failures among creditors delay necessary debt restructuring, leading to a persistent decline in aggregate productivity. We show that bank recapitalization or subsidies, conditional on debt restructuring, are more efficient than unconditional subsidies to borrowing firms, achieving economic recovery at a lower fiscal cost. Furthermore, we demonstrate that borrower subsidies, or expansionary fiscal policy more broadly, can inadvertently prolong stagnation by discouraging banks from restructuring debt.

Pages: 46
Date: 2026-09
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