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Costly default and skewed business cycles

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

European Economic Review, 2021, vol. 132, issue C

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)
JEL-codes: E32 E44 G21 (search for similar items in EconPapers)
Date: 2021
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Related works:
Working Paper: Costly default and skewed business cycle (2021) Downloads
Working Paper: Costly default and asymmetric real business cycles (2019) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:132:y:2021:i:c:s0014292120302609

DOI: 10.1016/j.euroecorev.2020.103630

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European Economic Review is currently edited by T.S. Eicher, A. Imrohoroglu, E. Leeper, J. Oechssler and M. Pesendorfer

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