Deepening Contractions and Collateral Constraints

Henrik Jensen, Søren Hove Ravn and Emiliano Santoro

No 11166, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The skewness of the US business cycle has become increasingly negative over the last decades. This finding can be explained by the concurrent increases in the loan-to-value ratios of both households and firms. To demonstrate this point, we devise a DSGE model with collateralized borrowing and occasionally non-binding credit constraints. Easier credit access increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further amplified due to tighter constraints. As a result, busts gradually become deeper than booms. Based on the differential impact that occasionally non-binding constraints exert on the shape of expansions and contractions, we are also able to reconcile a more negatively skewed business cycle with a moderation in its volatility. Finally, our model can account for an intrinsic feature of economic downturns preceded by private credit build-ups: Financially driven expansions lead to deeper contractions, as compared to equally-sized non-financial expansions.

Keywords: Credit constraints; Business cycles; Skewness; Deleveraging (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Date: 2016-03
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
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