DP18075 Long-term debt propagation and real reversals

• Mathias Drehmann Mikael Juselius Anton Korinek
13 Apr 2023

We examine a propagation mechanism that arises from households' long-term borrowing and show that it accounts for real reversals after credit booms. An impulse to new borrowing boosts output in the short run, but long-term debt generates a predictable hump-shaped path of debt service that depresses output far into the future. We confirm these patterns empirically using a novel multi-country dataset of debt flows. We embed long-term debt propagation in a New Keynesian model and show how credit shocks generate predictable reversals that are difficult for policymakers to counteract.