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Leverage and Deepening. Business Cycle Skewness

Henrik Jensen, Ivan Petrella, Soeren Hove Ravn and Emiliano Santoro
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Henrik Jensen: Department of Economics, University of Copenhagen
Ivan Petrella: Warwick Business School, University of Warwick
Soeren Hove Ravn: Department of Economics, University of Copenhagen
Emiliano Santoro: Department of Economics, University of Copenhagen

No 17-17, Discussion Papers from University of Copenhagen. Department of Economics

Abstract: We document that the U.S. economy has been characterized by an increasingly negative business cycle asymmetry over the last three decades. This fi?nding can be explained by the concurrent increase in the fi?nancial leverage of households and fi?rms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further ampli?ed due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, fi?nancially-driven expansions lead to deeper contractions, as compared with 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)
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
Date: 2017-08-24
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