TY - UNPB

T1 - Leverage and Deepening Business Cycle Skewness

AU - Jensen, Henrik

AU - Petrella, Ivan

AU - Ravn, Søren Hove

AU - Santoro, Emiliano

PY - 2017

Y1 - 2017

N2 - We document that the U.S. economy has 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. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further amplied due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

AB - We document that the U.S. economy has 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. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further amplied due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

KW - Faculty of Social Sciences

KW - Credit constraints

KW - business cycles

KW - skewness

KW - deleveraging

M3 - Working paper

T3 - University of Copenhagen. Institute of Economics. Discussion Papers (Online)

BT - Leverage and Deepening Business Cycle Skewness

ER -