Deepening Contractions and Collateral Constraints

TY - UNPB

T1 - Deepening Contractions and Collateral Constraints

AU - Jensen, Henrik

AU - Ravn, Søren Hove

AU - Santoro, Emiliano

N1 - Jel Classification: E32, E44

PY - 2016/3

Y1 - 2016/3

N2 - 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.

AB - 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.

KW - Faculty of Social Sciences

KW - E32

KW - E44

M3 - Working paper

T3 - CEPR Discussion Paper Series

BT - Deepening Contractions and Collateral Constraints

PB - Centre for Economic Policy Research, CEPR

CY - London

ER -