Going with the Flows: New Borrowing, Debt Service and the Transmission of Credit Booms

56 Pages Posted: 25 Apr 2018 Last revised: 27 Apr 2018

See all articles by Mathias Drehmann

Mathias Drehmann

Bank for International Settlements (BIS)

Mikael Juselius

Bank of Finland

Anton Korinek

University of Virginia - Department of Economics and Darden School of Business; National Bureau of Economic Research (NBER)

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Date Written: April 24, 2018

Abstract

Traditional economic models have had difficulty explaining the non-monotonic real effects of credit booms and, in particular, why they have predictable negative after-effects for up to a decade. We provide a systematic transmission mechanism by focusing on the flows of resources between borrowers and lenders, i.e. new borrowing and debt service. We construct the first cross-country dataset of these flows for a panel of house-hold debt in 16 countries. We show that new borrowing increases economic activity but generates a pre-specified path of debt service that reduces future economic activity. The protracted response in debt service derives from two key analytic properties of credit booms: (i) new borrowing is auto-correlated and (ii) debt contracts are long term. We confirm these properties in the data and show that debt service peaks on average four years after credit booms and is associated with significantly lower output and higher crisis risk. Our results explain the transmission mechanism through which credit booms and busts generate non-monotonic and long-lasting aggregate demand effects and are, hence, crucial for macroeconomic stabilization policy.

Keywords: new borrowing, debt service, financial cycle, financial flows and real effects

JEL Classification: E17, E44, G01, D14

Suggested Citation

Drehmann, Mathias and Juselius, Mikael and Korinek, Anton, Going with the Flows: New Borrowing, Debt Service and the Transmission of Credit Booms (April 24, 2018). Bank of Finland Research Discussion Paper No. 10/2018, Available at SSRN: https://ssrn.com/abstract=3168448

Mathias Drehmann (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Mikael Juselius

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Anton Korinek

University of Virginia - Department of Economics and Darden School of Business ( email )

248 McCormick Rd
Charlottesville, VA 22904
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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