Deleverage and Financial Fragility

42 Pages Posted: 9 Apr 2015

See all articles by Marco Maffezzoli

Marco Maffezzoli

Bocconi University - Department of Economics

Tommaso Monacelli

Bocconi University - Department of Economics

Date Written: April 2015

Abstract

Empirical evidence suggests that severe economic downturns, characterized by deleverage, are preceded by phenomena of debt overhang. Hence large recessions may not result from large shocks, but, rather, from typical shocks interacting with the state of the economy. We study a stochastic economy with heterogeneous agents and occasionally binding collateral constraints, where private debt evolves endogenously. The effect of deleverage shocks on aggregate output is a non-linear, S-shaped, function of the accumulated level of debt, i.e., of the degree of financial fragility. These results cast doubts on the accuracy of gauging the effects of financial disturbances in linearized, certainty-equivalence environments.

Keywords: aggregate fluctuations, deleverage, financial fragility, nonlinearities

JEL Classification: E32, E44

Suggested Citation

Maffezzoli, Marco and Monacelli, Tommaso, Deleverage and Financial Fragility (April 2015). CEPR Discussion Paper No. DP10531. Available at SSRN: https://ssrn.com/abstract=2592373

Marco Maffezzoli (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Tommaso Monacelli

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

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