Discussion Paper Details

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Title: Leverage and Deepening Business Cycle Skewness

Author(s): Henrik Jensen, Ivan Petrella, Søren Hove Ravn and Emiliano Santoro

Publication Date: August 2017

Keyword(s): business cycles, credit constraints, Deleveraging and Skewness

Programme Area(s): International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: We document that the U.S. and other G7 economies have been characterized by an increasingly negative business cycle asymmetry over the last three decades. This finding can be explained by the concurrent increase in the financial leverage of households and firms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Improved access to credit increases the likelihood that financial constraints become non-binding in the face of expansionary shocks, allowing agents to freely substitute intertemporally. Contractionary shocks, on the other hand, are further amplified by drops in collateral values, since constraints remain binding. As a result, booms become progressively smoother and more prolonged than busts. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

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Bibliographic Reference

Jensen, H, Petrella, I, Ravn, S and Santoro, E. 2017. 'Leverage and Deepening Business Cycle Skewness'. London, Centre for Economic Policy Research.