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Leverage and Deepening Business Cycle Skewness

Author

Listed:
  • Jensen, Henrik

    (University of Copenhagen)

  • Petrella, Ivan

    (University of Warwick)

  • Ravn, Soren

    (University of Copenhagen)

  • Santoro, Emiliano

    (University of Copenhagen)

Abstract

We document that the U.S. and other G7 economies have been characterized by an increasingly negative business cycle asymmetry over the last three decades. This finding can be explained by the concurrent increase in the financial leverage of households and firms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Improved access to credit increases the likelihood that financial constraints become non-binding in the face of expansionary shocks, allowing agents to freely substitute intertemporally. Contractionary shocks, on the other hand, are further amplified by drops in collateral values, since constraints remain binding. As a result, booms become progressively smoother and more prolonged than busts. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

Suggested Citation

  • Jensen, Henrik & Petrella, Ivan & Ravn, Soren & Santoro, Emiliano, 2019. "Leverage and Deepening Business Cycle Skewness," EMF Research Papers 21, Economic Modelling and Forecasting Group.
  • Handle: RePEc:wrk:wrkemf:21
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    File URL: https://warwick.ac.uk/fac/soc/wbs/subjects/finance/mpf/working-papers/emf_wp_20.pdf
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    More about this item

    Keywords

    Credit constraints; business cycles; skewness; deleveraging; JEL Classification Numbers: E32 ; E44;

    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

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