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Real Credit Cycles

Author

Listed:
  • Pedro Bordalo
  • Nicola Gennaioli
  • Andrei Shleifer
  • Stephen J. Terry

Abstract

We incorporate diagnostic expectations into a workhorse neoclassical business cycle model with heterogeneous firms and risky debt. A realistic degree of diagnostic overreaction estimated from US firm forecasts generates economic fragility during good times, countercyclical credit spreads, and boom-bust credit cycles at the firm and aggregate levels. Good times predict future disappointment, spread increases, low bond returns, and investment declines. To generate the size of spread increases observed during 2008-9, the model requires only disappointment of overoptimistic beliefs rather than large negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.

Suggested Citation

  • Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer & Stephen J. Terry, 2021. "Real Credit Cycles," NBER Working Papers 28416, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:28416
    Note: CF EFG
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    Cited by:

    1. Robin Greenwood & Samuel G. Hanson & Andrei Shleifer & Jakob Ahm Sørensen, 2022. "Predictable Financial Crises," Journal of Finance, American Finance Association, vol. 77(2), pages 863-921, April.
    2. Andrea Ajello & Nina Boyarchenko & François Gourio & Andrea Tambalotti, 2022. "Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms," Finance and Economics Discussion Series 2022-005, Board of Governors of the Federal Reserve System (U.S.).
    3. Pablo Guerrón-Quintana & Alexey Khazanov & Molin Zhong, 2023. "Financial and Macroeconomic Data Through the Lens of a Nonlinear Dynamic Factor Model," Finance and Economics Discussion Series 2023-027, Board of Governors of the Federal Reserve System (U.S.).
    4. Pablo Pastory y Camarasa & Martien Lamers, 2023. "Do Actions Follow Words? How bank sentiment predicts credit growth," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 23/1073, Ghent University, Faculty of Economics and Business Administration.
    5. Barrero, Jose Maria, 2022. "The micro and macro of managerial beliefs," Journal of Financial Economics, Elsevier, vol. 143(2), pages 640-667.

    More about this item

    JEL classification:

    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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