DP11166 Deepening Contractions and Collateral Constraints
|Author(s):||Henrik Jensen, Søren Hove Ravn, Emiliano Santoro|
|Publication Date:||March 2016|
|Keyword(s):||Business Cycles, credit constraints, Deleveraging, Skewness|
|Programme Areas:||Monetary Economics and Fluctuations|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=11166|
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.