Events at CERGE-EI

Wei Cui, Ph.D.

University College London, United Kingdom

Authors: Wei Cui and Leo Kaas

Abstract: Recessions are often accompanied by spikes of corporate default  and prolonged de- clines of business credit. This paper argues that credit and default cycles are outcomes of variations in self-fulfilling beliefs about credit market  conditions.  We  develop a tractable macroeconomic model in which credit contracts reflect the expected default risk of borrowing firms. We calibrate the model to evaluate the macroeconomic impact of sunspots and fundamental shocks. Self-fulfilling changes in credit market expecta- tions generate sizable reactions in default rates and endogenously persistent credit and output cycles. Credit market shocks account for half of the variation of U.S. output growth during 1982–2015.

JEL classification: E22, E32, E44, G12

Keywords: Firm default; Financing constraints; Credit spreads; Sunspots

Full Text:  “Default Cycles”