Slow Debt, Deep Recessions

57 Pages Posted: 2 Dec 2020

See all articles by Joachim Jungherr

Joachim Jungherr

University of Bonn

Immo Schott

University of Montreal - Department of Economics

Date Written: March 1, 2020

Abstract

Business credit lags GDP growth by about one year. This contributes to high leverage during recessions and slow deleveraging. We show that a model in which firms use risky long-term debt replicates this slow adjustment of firm debt. In the model, slow-moving debt has important effects for real activity. High levels of firm debt issued during expansions are only gradually reduced during recessions. This generates an adverse feedback loop between high default rates and low investment and thereby amplifies the downturn. Sluggish deleveraging slows down the recovery. The equilibrium is constrained inefficient because firms exert an externality on the holders of previously issued debt. The constrained efficient allocation substantially reduces macroeconomic volatility.

Keywords: business cycles, firm financing, long-term debt

JEL Classification: E32, E44, G32

Suggested Citation

Jungherr, Joachim and Schott, Immo, Slow Debt, Deep Recessions (March 1, 2020). Available at SSRN: https://ssrn.com/abstract=3714863 or http://dx.doi.org/10.2139/ssrn.3714863

Joachim Jungherr (Contact Author)

University of Bonn

Germany

Immo Schott

University of Montreal - Department of Economics

C.P. 6128, succursale Centre-Ville
C-6028
Montreal, Quebec H3C 3J7 H2W1R9
Canada

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