Leverage, Default, and Forgiveness: Lessons from the American and European Crises

John Geanakoplos

Journal of Macroeconomics, 2014, vol. 39, issue PB, 313-333

Abstract: This paper argues that macroeconomic stability depends less on riskless interest rates than on leverage and other measures of credit conditions, like average FICO scores of borrowers. It suggests that the leverage cycle played a central role in the recent American and European financial crisis. In the leverage cycle, asset prices and leverage rise when volatility is low and then fall as volatility rises. Sometimes asset prices fall so far below debt levels that it would be better for everybody if debt were partially forgiven. The paper recommends that central banks regularly monitor and forecast the whole credit surface, and in extreme cases intervene to regulate risky interest rates and impose partial debt forgiveness.

Keywords: Leverage cycle; American and European crises; Credit surface; Debt forgiveness (search for similar items in EconPapers)
JEL-codes: E44 G01 G18 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:39:y:2014:i:pb:p:313-333

DOI: 10.1016/j.jmacro.2014.01.001

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