Changing Credit Limits, Changing Business Cycles

56 Pages Posted: 2 Mar 2015

See all articles by Henrik Jensen

Henrik Jensen

University of Copenhagen - Department of Economics; Centre for Economic Policy Research (CEPR)

Søren Hove Ravn

University of Copenhagen

Emiliano Santoro

Catholic University of the Sacred Heart of Milan - Department of Economics

Date Written: March 2015

Abstract

In the last decades, capital markets across the industrialized world have undergone massive deregulation, involving increases in the loan-to-value (LTV) ratios of households and firms. We study the business-cycle implications of this phenomenon in a dynamic general equilibrium model with multiple credit-constrained agents. Starting from low LTV ratios, a progressive relaxation of credit constraints leads to both higher macroeconomic volatility and stronger comovement between debt and real variables. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, since credit constraints become non-binding more often. As expansionary shocks may make credit constraints non-binding, while contractionary shocks cannot, recessions become deeper than expansions. The non-monotonic relationship between credit market conditions and macroeconomic fluctuations poses a serious challenge for regulatory and macroprudential policies.

Keywords: business cycles, capital-market liberalization, capital-market regulation, occasionally non-binding contract constraints

JEL Classification: E32, E44

Suggested Citation

Jensen, Henrik and Ravn, Søren Hove and Santoro, Emiliano, Changing Credit Limits, Changing Business Cycles (March 2015). CEPR Discussion Paper No. DP10462. Available at SSRN: https://ssrn.com/abstract=2572460

Henrik Jensen (Contact Author)

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark
+45 35 323 043 (Phone)
+45 35 323 000 (Fax)

HOME PAGE: http://hjeconomics.dk

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Søren Hove Ravn

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

Emiliano Santoro

Catholic University of the Sacred Heart of Milan - Department of Economics ( email )

20123 Milano
Italy

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