Working Paper: CEPR ID: DP18075
Authors: Mathias Drehmann; Mikael Juselius; Anton Korinek
Abstract: We examine a propagation mechanism that arises from households' long-term borrowing and show empirically that it has sizable real effects. The mechanism recognises that when there is long-term debt, an impulse to new borrowing generates a predictable hump-shaped path of future debt service. We confirm this pattern using a novel multi-country dataset of debt flows. Whereas new borrowing boosts output contemporaneously, debt service depresses output. Credit booms thus lead to predictable reversals in real economic activity several years later. This long-term debt propagation channel is the main reason for why indicators of credit cycles have predictive power for future economic activity.
Keywords: new borrowing; debt service; financial cycle; financial flows; real effects
JEL Codes: E17; E44; G01; D14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| new borrowing (G51) | future debt service payments (H63) |
| new borrowing (G51) | output growth (O40) |
| debt service (H63) | output growth (O40) |
| new borrowing (G51) | peak in debt service (F34) |
| debt service peaks (F34) | output growth (O40) |