Credit, Bankruptcy, and Aggregate Fluctuations

44 Pages Posted: 29 Oct 2014

See all articles by Makoto Nakajima

Makoto Nakajima

Federal Reserve Bank of Philadelphia

José-Victor Rios-Rull

University of Pennsylvania - Department of Economics; NBER Research Associate

Multiple version iconThere are 4 versions of this paper

Date Written: October 20, 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.

Keywords: Consumer Credit, Default, Bankruptcy, Debt, Business Cycle, Heterogeneous Agents, Incomplete Markets

JEL Classification: D91, E21, E32, E44, K35

Suggested Citation

Nakajima, Makoto and Rios-Rull, José-Victor, Credit, Bankruptcy, and Aggregate Fluctuations (October 20, 2014). FRB of Philadelphia Working Paper No. 14-31, Available at SSRN: https://ssrn.com/abstract=2515328 or http://dx.doi.org/10.2139/ssrn.2515328

Makoto Nakajima (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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José-Victor Rios-Rull

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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