DP8678 When Credit Bites Back: Leverage, Business Cycles, and Crises

Author(s): Ņscar Jordą, Moritz Schularick, Alan M. Taylor
Publication Date: December 2011
Date Revised: October 2012
Keyword(s): business cycles, financial crises, leverage, local projections
JEL(s): C14, C52, E51, F32, F42, N10, N20
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=8678

This paper studies the role of credit in the business cycle, with a focus on private credit overhang. Based on a study of the universe of over 200 recession episodes in 14 advanced countries between 1870 and 2008, we document two key facts of the modern business cycle: financial-crisis recessions are more costly than normal recessions in terms of lost output; and for both types of recession, more credit-intensive expansions tend to be followed by deeper recessions and slower recoveries. In additional to unconditional analysis, we use local projection methods to condition on a broad set of macroeconomic controls and their lags. Then we study how past credit accumulation impacts the behavior of not only output but also other key macroeconomic variables such as investment, lending, interest rates, and inflation. The facts that we uncover lend support to the idea that financial factors play an important role in the modern business cycle.