Credit, Bankruptcy, and Aggregate Fluctuations

44 Pages Posted: 27 Oct 2014

See all articles by Makoto Nakajima

Makoto Nakajima

Federal Reserve Bank of Philadelphia

Jose-Victor Rios-Rull

University of Minnesota - Twin Cities

Multiple version iconThere are 4 versions of this paper

Date Written: October 2014

Abstract

We ask two questions related to how access to credit affects the nature of business cycles. First, does the standard theory of unsecured credit account for the high volatility and procyclicality of credit and the high volatility and countercyclicality of bankruptcy filings found in U.S. data? Yes, it does, but only if we explicitly model recessions as displaying countercyclical earnings risk (i.e., rather than having all households fare slightly worse than normal during recessions, we ensure that more households than normal fare very poorly). Second, does access to credit smooth aggregate consumption or aggregate hours worked, and if so, does it matter with respect to the nature of business cycles? No, it does not; in fact, consumption is 20 percent more volatile when credit is available. The interest rate premia increase in recessions because of higher bankruptcy risk discouraging households from using credit. This finding contradicts the intuition that access to credit helps households to smooth their consumption.

Suggested Citation

Nakajima, Makoto and Rios-Rull, Jose-Victor, Credit, Bankruptcy, and Aggregate Fluctuations (October 2014). NBER Working Paper No. w20617, Available at SSRN: https://ssrn.com/abstract=2515195

Makoto Nakajima (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Jose-Victor Rios-Rull

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

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