Working Paper: CEPR ID: DP10531
Authors: Marco Maffezzoli; Tommaso Monacelli
Abstract: Empirical evidence suggests that severe economic downturns, characterized by deleverage, are preceded by phenomena of debt overhang. Hence large recessions may not result from large shocks, but, rather, from typical shocks interacting with the state of the economy. We study a stochastic economy with heterogeneous agents and occasionally binding collateral constraints, where private debt evolves endogenously. The effect of deleverage shocks on aggregate output is a non-linear, S-shaped, function of the accumulated level of debt, i.e., of the degree of financial fragility. These results cast doubts on the accuracy of gauging the effects of financial disturbances in linearized, certainty-equivalence environments.
Keywords: aggregate fluctuations; deleverage; financial fragility; nonlinearities
JEL Codes: E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deleverage shocks (F65) | recessions (E32) |
| deleverage shocks (F65) | consumption (E21) |
| binding borrowing constraint (F34) | consumption (E21) |
| deleveraging shocks (F65) | aggregate output (E10) |
| accumulated debt (H63) | impact of deleverage shocks (F65) |
| financial frictions (G19) | recessions (E32) |
| debt-to-output ratio (C67) | impact of deleverage shocks (F65) |