Working Paper: CEPR ID: DP10462
Authors: Henrik Jensen; Sren Hove Ravn; Emiliano Santoro
Abstract: In the last decades, capital markets across the industrialized world have undergone massive deregulation, involving increases in the loan-to-value (LTV) ratios of households and firms. We study the business-cycle implications of this phenomenon in a dynamic general equilibrium model with multiple credit-constrained agents. Starting from low LTV ratios, a progressive relaxation of credit constraints leads to both higher macroeconomic volatility and stronger comovement between debt and real variables. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, since credit constraints become non-binding more often. As expansionary shocks may make credit constraints non-binding, while contractionary shocks cannot, recessions become deeper than expansions. The non-monotonic relationship between credit market conditions and macroeconomic fluctuations poses a serious challenge for regulatory and macroprudential policies.
Keywords: business cycles; capital market liberalization; capital market regulation; non-binding contract constraints
JEL Codes: E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher LTV ratios (G32) | Increased macroeconomic volatility (E32) |
| Higher LTV ratios (G32) | Stronger comovement between debt and real activity (E44) |
| Increased LTV ratios (G32) | Higher likelihood of credit constraints becoming non-binding (E51) |
| Higher LTV ratios (G32) | Diminished impact of positive shocks on the economy (F69) |
| Higher LTV ratios (G32) | Larger output fluctuations (E32) |
| Higher LTV ratios (G32) | Procyclical credit issuance (E51) |
| Non-binding credit constraints (E51) | Weaker economic responses to positive shocks (E65) |
| Technology shocks (O33) | Amplified by collateral constraints (D10) |
| Financial shocks (F65) | Account for output fluctuations under high LTV conditions (E32) |
| Tighter credit limits (E51) | Increase output volatility (E39) |