A Macro-Finance model with Realistic Crisis Dynamics

Abstract

What causes deep recessions and slow recovery? I revisit this question and develop a macro-finance model that quantitatively matches the salient empirical features of financial crises such as a large drop in the output, a high risk premium, reduced financial intermediation, and a long duration of economic distress. The model has leveraged intermediaries featuring stochastic productivity and a regime-dependent exit rate that governs the transition in and out of crises. A model without these two features suffers from a trade-off between the amplification and persistence of crises. I show that my model resolves this tension and generates realistic crisis dynamics.

Keywords: Financial Intermediation, Risk Premium, Financial Crises

JEL Classification: G01, E44, G12