Learning Financial Shocks and the Great Recession

Patrick Pintus and Jacek Suda

Review of Economic Dynamics, 2019, vol. 31, 123-146

Abstract: This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning the uncertain environment. Agents update their beliefs about the reduced-form structure of the economy. Because the persistence of leverage is overestimated by adaptive learners, the responses of output, investment, 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 that the persistence of leverage shocks is increasingly overestimated after 2002 and that a sizeable recession occurs in 2008–2010, 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 that enforce countercyclical leverage dampen the effects of leverage shocks. (Copyright: Elsevier)

Keywords: Collateral constraints; Adaptive learning; Financial shocks; Great Recession (search for similar items in EconPapers)
JEL-codes: E32 E44 G18 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (6)

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Working Paper: Learning Financial Shocks and the Great Recession (2019)
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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 (2015)
Working Paper: Learning Financial Shocks and the Great Recession (2013)
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DOI: 10.1016/j.red.2018.06.002

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