IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Learning Financial Shocks and the Great Recession

This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning their economic environment. When agents update their beliefs about the unobserved process driving financial shocks to the leverage ratio, the responses of output and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with the actual leverage innovations, the learning model predicts the correct magnitude for the Great Recession, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the impact of learning and, accordingly, that macro-prudential policies enforcing countercyclical leverage dampen the effects of leverage shocks. Finally, we illustrate how learning with a misspecified model that ignores real/financial linkages also contributes to magnify financial shocks.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.amse-aixmarseille.fr/sites/default/files/_dt/2012/wp_2013_-_nr_33.pdf
Download Restriction: no

Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1333.

as
in new window

Length: 52 pages
Date of creation: 05 Jun 2013
Date of revision: 05 Jun 2013
Handle: RePEc:aim:wpaimx:1333
Contact details of provider: Web page: http://www.amse-aixmarseille.fr/en

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Boz, Emine & Mendoza, Enrique G, 2010. "Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis," CEPR Discussion Papers 7967, C.E.P.R. Discussion Papers.
  2. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA.
  3. Pei Kuang, 2013. "Imperfect Knowledge about Asset Prices and Credit Cycles," Discussion Papers 13-02, Department of Economics, University of Birmingham.
  4. Klaus Adam & Pei Kuang & Albert Marcet, 2011. "House Price Booms and the Current Account," NBER Working Papers 17224, National Bureau of Economic Research, Inc.
  5. Andreas Fuster & Benjamin Hebert & David Laibson, 2011. "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing," NBER Working Papers 17301, National Bureau of Economic Research, Inc.
  6. Thomas Philippon & Virgiliu Midrigan, 2011. "Household Leverage and the Recession," NBER Working Papers 16965, National Bureau of Economic Research, Inc.
  7. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  8. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  9. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-72, October.
  10. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  11. Nobuhiro Kiyotaki & Alexander Michaelides & Kalin Nikolov, 2011. "Winners and Losers in Housing Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 255-296, 03.
  12. Chakraborty, Avik & Evans, George W., 2008. "Can perpetual learning explain the forward-premium puzzle?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 477-490, April.
  13. Patrick A. Pintus & Yi Wen, 2010. "Leveraged borrowing and boom-bust cycles," Working Papers 2010-027, Federal Reserve Bank of St. Louis.
  14. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2004. "Learning and shifts in long-run productivity growth," Finance and Economics Discussion Series 2004-21, Board of Governors of the Federal Reserve System (U.S.).
  15. James B. Bullard & John Duffy, 2004. "Learning and structural change in macroeconomic data," Working Papers 2004-016, Federal Reserve Bank of St. Louis.
  16. Aiyagari, S.R. & Gertler, M., 1998. ""Overreaction" of Asset Prices in General Equilibrium," Working Papers 98-25, C.V. Starr Center for Applied Economics, New York University.
  17. repec:fth:starer:9825 is not listed on IDEAS
  18. Milani, Fabio, 2010. "Expectation Shocks and Learning as Drivers of the Business Cycle," CEPR Discussion Papers 7743, C.E.P.R. Discussion Papers.
  19. Piketty, Thomas & Banerjee, Abhijit & Aghion, Philippe, 1999. "Dualism and Macroeconomic Volatility," Scholarly Articles 4554124, Harvard University Department of Economics.
  20. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, vol. 91(2), pages 158-166, May.
  21. Atif R. Mian & Amir Sufi, 2009. "House Prices, Home Equity-Based Borrowing, and the U.S. Household Leverage Crisis," NBER Working Papers 15283, National Bureau of Economic Research, Inc.
  22. Dan Cao, 2011. "Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs," Working Papers gueconwpa~11-11-01, Georgetown University, Department of Economics.
  23. Aiyagari, S.R. & Gertler, M., 1998. ""Overreaction" of Asset Prices in General Equilibrium," Working Papers 98-25, C.V. Starr Center for Applied Economics, New York University.
  24. Enrique G. Mendoza & Emine Boz, 2010. "Financial innovation, the Discovery of Risk, and the U.S. Credit Crisis," IMF Working Papers 10/164, International Monetary Fund.
  25. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  26. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
  27. Campbell, Jeffrey R. & Hercowitz, Zvi, 2009. "Welfare implications of the transition to high household debt," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 1-16, January.
  28. George W. Evans, 2011. "Comment on "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing"," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 61-71 National Bureau of Economic Research, Inc.
  29. Fuster, Andreas & Hebert, Benjamin Michael & Laibson, David I., 2012. "Investment Dynamics with Natural Expectations," Scholarly Articles 10139283, Harvard University Department of Economics.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:aim:wpaimx:1333. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Yves Doazan)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.