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The Long-term Debt Accelerator

Joachim Jungherr and Immo Schott
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Joachim Jungherr: IAE (CSIC), MOVE, and Barcelona GSE

No 961, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We introduce risky long-term debt to a standard model of firm financing and investment. This allows us to identify a novel amplification mechanism: the Long-term Debt Accelerator. A negative shock triggers an adverse feedback loop between low investment and high credit spreads. Relative to a frictionless RBC setup, the Long-term Debt Accelerator amplifies shocks by about 160%. This amplification mechanism is absent from standard models including only short-term debt. Negative shocks are more severe than positive shocks of equal size and amplification is stronger for larger shocks. If fundamental volatility is lower and firms accumulate more debt, recessions become more severe. The Long-term Debt Accelerator is in line with the empirically observed cyclical behavior of credit spreads, leverage, and debt maturity.

New Economics Papers: this item is included in nep-dge, nep-fdg and nep-mac
Date: 2018
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