Leverage and Deepening Business Cycle Skewness

Research output: Working paperResearch

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.
Original languageEnglish
Number of pages63
Publication statusPublished - 2017
SeriesUniversity of Copenhagen. Institute of Economics. Discussion Papers (Online)
Number17-17
ISSN1601-2461

ID: 182541336