Deepening Contractions and Collateral Constraints

Research output: Working paperResearch

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.
Original languageEnglish
Place of PublicationLondon
PublisherCentre for Economic Policy Research, CEPR
Publication statusPublished - Mar 2016
SeriesCEPR Discussion Paper Series
Number11166
Volume2016

Bibliographical note

Jel Classification: E32, E44

ID: 157501717