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Changing credit limits, changing business cycles

Henrik Jensen (), Søren Hove Ravn and Emiliano Santoro ()

European Economic Review, 2018, vol. 102, issue C, 211-239

Abstract: In the last half-century, capital markets across the industrialized world have undergone massive deregulation, involving large increases in the loan-to-value (LTV) ratios of households and firms. We study the business-cycle implications of this phenomenon in an estimated dynamic general equilibrium model with multiple credit-constrained agents. A progressive relaxation of credit constraints initially leads to both higher macroeconomic volatility and stronger comovement between debt and real activity. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, due to credit constraints becoming non-binding more often. The non-monotonic relationship between credit market conditions and macroeconomic fluctuations carries important lessons for regulatory and macroprudential policymakers. While reducing the average LTV ratio may unintentionally increase macroeconomic volatility, a countercyclical LTV ratio proves to be successful in dampening business cycle fluctuations and, most importantly, avoiding dramatic output drops.

Keywords: Occasionally binding credit constraints; Business cycles; Capital-market liberalization; Macroprudential policy (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Date: 2018
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