Structural Reforms in a Debt Overhang
47 Pages Posted: 30 Jul 2014
Date Written: July 29, 2014
We assess the effects of reforms in product and labor markets in a model economy featuring credit restrictions and pre-existing long-term debt. Both elements, which are core features of the current scenario faced by some euro area countries, combine to produce a slow and protracted deleveraging of the private sector and a persistent recession following a negative financial shock. In this environment, we show that product and labor market reforms may stimulate output and employment even in the short run, despite their deflationary effects. Furthermore, by favoring a faster recovery of investment and collateral values, product market reforms bring forward the end of deleveraging and the exit from recession.
Keywords: deleveraging, collateral constraints, long-run debt, structural reforms
JEL Classification: E43, E44, E65, G21
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