Changing credit limits, changing business cycles

TY - JOUR

T1 - Changing credit limits, changing business cycles

AU - Jensen, Henrik

AU - Ravn, Søren Hove

AU - Santoro, Emiliano

PY - 2018/2

Y1 - 2018/2

N2 - In the last half-century, capital markets across the industrialized world have undergone massive deregulation, involving large increases in the loan-to-value (LTV) ratios of house- holds and firms. We study the business-cycle implications of this phenomenon in an es- timated dynamic general equilibrium model with multiple credit-constrained agents. A progressive relaxation of credit constraints initially leads to both higher macroeconomic volatility and stronger comovement between debt and real activity. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, due to credit constraints becoming non-binding more often. The non-monotonic relationship be- tween credit market conditions and macroeconomic fluctuations carries important lessons for regulatory and macroprudential policymakers. While reducing the average LTV ratio may unintentionally increase macroeconomic volatility, a countercyclical LTV ratio proves to be successful in dampening business cycle fluctuations and, most importantly, avoiding dramatic output drops.

AB - In the last half-century, capital markets across the industrialized world have undergone massive deregulation, involving large increases in the loan-to-value (LTV) ratios of house- holds and firms. We study the business-cycle implications of this phenomenon in an es- timated dynamic general equilibrium model with multiple credit-constrained agents. A progressive relaxation of credit constraints initially leads to both higher macroeconomic volatility and stronger comovement between debt and real activity. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, due to credit constraints becoming non-binding more often. The non-monotonic relationship be- tween credit market conditions and macroeconomic fluctuations carries important lessons for regulatory and macroprudential policymakers. While reducing the average LTV ratio may unintentionally increase macroeconomic volatility, a countercyclical LTV ratio proves to be successful in dampening business cycle fluctuations and, most importantly, avoiding dramatic output drops.

KW - Faculty of Social Sciences

KW - Occasionally binding credit constraints

KW - Business cycles

KW - Capital-market liberalization

KW - Macroprudential policy

U2 - 10.1016/j.euroecorev.2017.12.008

DO - 10.1016/j.euroecorev.2017.12.008

M3 - Journal article

SN - 0014-2921

VL - 102

SP - 211

EP - 239

JO - European Economic Review

JF - European Economic Review

ER -