IDEAS home Printed from https://ideas.repec.org/p/hal/wpaper/halshs-00830480.html
   My bibliography  Save this paper

Learning Financial Shocks and the Great Recession

Author

Listed:
  • Patrick A. Pintus

    () (Banque de France, GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université - EHESS - École des hautes études en sciences sociales)

  • Jacek Suda

    () (National Bank of Poland, Economic Institute)

Abstract

This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning the uncertain environment. When agents update their beliefs about the parameters that govern the unobserved process driving financial shocks to the leverage ratio, the responses of output, investment, 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 actual leverage innovations observed over that period, the learning model predicts that the persistence of leverage shocks is increasingly overestimated after 2002 and that a sizeable recession occurs in 2008-10, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the amplification due to learning and, accordingly, that macro-prudential policies that enforce countercyclical leverage dampen the effects of leverage shocks.

Suggested Citation

  • Patrick A. Pintus & Jacek Suda, 2016. "Learning Financial Shocks and the Great Recession," Working Papers halshs-00830480, HAL.
  • Handle: RePEc:hal:wpaper:halshs-00830480
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00830480v5
    as

    Download full text from publisher

    File URL: https://halshs.archives-ouvertes.fr/halshs-00830480v5/document
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Klaus Adam & Pei Kuang & Albert Marcet, 2012. "House Price Booms and the Current Account," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 77-122.
    2. repec:fth:starer:98-25 is not listed on IDEAS
    3. Andreas Fuster & Benjamin Hebert & David Laibson, 2012. "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 1-48.
    4. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2015. "Household leveraging and deleveraging," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(1), pages 3-20, January.
    5. Thomas Chaney & David Sraer & David Thesmar, 2012. "The Collateral Channel: How Real Estate Shocks Affect Corporate Investment," American Economic Review, American Economic Association, vol. 102(6), pages 2381-2409, October.
    6. Boz, Emine & Mendoza, Enrique G., 2014. "Financial innovation, the discovery of risk, and the U.S. credit crisis," Journal of Monetary Economics, Elsevier, vol. 62(C), pages 1-22.
    7. Roberto Pancrazi & Mario Pietrunti, 2014. "Natural Expectations and Home Equity Extraction," Temi di discussione (Economic working papers) 984, Bank of Italy, Economic Research and International Relations Area.
    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. Philippe Aghion & Abhijit Banerjee & Thomas Piketty, 1999. "Dualism and Macroeconomic Volatility," The Quarterly Journal of Economics, Oxford University Press, vol. 114(4), pages 1359-1397.
    10. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-2872, October.
    11. 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.
    12. Midrigan, Virgiliu & Philippon, Thomas, 2011. "Household Leverage and the Recession," CEPR Discussion Papers 8381, C.E.P.R. Discussion Papers.
    13. repec:fth:starer:9825 is not listed on IDEAS
    14. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    15. 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, March.
    16. Michael Woodford, 2013. "Macroeconomic Analysis Without the Rational Expectations Hypothesis," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 303-346, May.
    17. Kuang, Pei, 2014. "A model of housing and credit cycles with imperfect market knowledge," European Economic Review, Elsevier, vol. 70(C), pages 419-437.
    18. Eva Carceles-Poveda & Chryssi Giannitsarou, 2008. "Asset Pricing with Adaptive Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 629-651, July.
    19. Dan Vu Cao, 2010. "Collateral Shortages, Asset Price And Investment Volatility With Heterogeneous Beliefs," 2010 Meeting Papers 1233, Society for Economic Dynamics.
    20. 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.
    21. Patrick Pintus & Yi Wen, 2013. "Leveraged Borrowing and Boom-Bust Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 617-633, October.
    22. Lawrence J. Christiano & Martin S. Eichenbaum & Mathias Trabandt, 2015. "Understanding the Great Recession," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 110-167, January.
    23. Atif Mian & Amir Sufi, 2011. "House Prices, Home Equity-Based Borrowing, and the US Household Leverage Crisis," American Economic Review, American Economic Association, vol. 101(5), pages 2132-2156, August.
    24. 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.
    25. S. Rao Aiyagari & Mark Gertler, 1999. ""Overreaction" of Asset Prices in General Equilibrium," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 3-35, January.
    26. Urban Jermann & Vincenzo Quadrini, 2012. "Erratum: Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(2), pages 1186-1186, April.
    27. Zheng Liu & Pengfei Wang & Tao Zha, 2013. "Land‐Price Dynamics and Macroeconomic Fluctuations," Econometrica, Econometric Society, vol. 81(3), pages 1147-1184, May.
    28. Gelain, Paolo & Lansing, Kevin J., 2014. "House prices, expectations, and time-varying fundamentals," Journal of Empirical Finance, Elsevier, vol. 29(C), pages 3-25.
    29. Pei Kuang, 2013. "Imperfect Knowledge about Asset Prices and Credit Cycles," Discussion Papers 13-02, Department of Economics, University of Birmingham.
    30. 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.
    31. Edge, Rochelle M. & Laubach, Thomas & Williams, John C., 2007. "Learning and shifts in long-run productivity growth," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2421-2438, November.
    32. Fabio Milani, 2011. "Expectation Shocks and Learning as Drivers of the Business Cycle," Economic Journal, Royal Economic Society, vol. 121(552), pages 379-401, May.
    33. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(1), pages 238-271, February.
    34. Eva Carceles-Poveda & Chryssi Giannitsarou, 2008. "Asset Pricing with Adaptive Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 629-651, July.
    35. Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October.
    36. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, vol. 91(2), pages 158-166, May.
    37. 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.
    38. James B. Bullard & John Duffy, 2004. "Learning and structural change in macroeconomic data," Working Papers 2004-016, Federal Reserve Bank of St. Louis.
    39. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
    40. 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)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Venky Venkateswaran & Laura Veldkamp & Julian Kozlowski, 2015. "The Tail that Wags the Economy: Belief-Driven Business Cycles and Persistent Stagnation," 2015 Meeting Papers 800, Society for Economic Dynamics.
    2. Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2015. "The Tail that Wags the Economy: Beliefs and Persistent Stagnation," NBER Working Papers 21719, National Bureau of Economic Research, Inc.
    3. Martin Guzman & Joseph E. Stiglitz, 2016. "Pseudo-wealth and Consumption Fluctuations," NBER Working Papers 22838, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    collateral constraints; learning; financial shocks; Great Recession;

    JEL classification:

    • 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
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hal:wpaper:halshs-00830480. 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: (CCSD). General contact details of provider: https://hal.archives-ouvertes.fr/ .

    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 CitEc recognized a reference but did not link an item in RePEc 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.