Fève, Patrick, Garcia Sanchez, Pablo, Moura, Alban and Pierrard, Olivier (2021) Costly default and skewed business cycle. European Economic Review, vol. 132.

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Abstract

We augment a simple Real Business Cycle model with financial intermediaries that may default on their liabilities and a financial friction generating social costs of default. We derive a closed-form solution for the general equilibrium of the economy, providing analytical results. Endogenous default generates a negative skew for aggregate variables and a positive skew for credit spreads, as documented in the empirical literature. Larger financial frictions strengthen asymmetry, which amplifies the welfare cost of fluctuations. Macro-prudential regulation alleviates both the cost of fluctuations and business-cycle asymmetry, at the expense of a steady-state distortion. Finally, we prove analytically the existence of an optimal level of regulation, which increases with the size of the financial friction.

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• Costly default and asymetric real business cycles. (deposited 14 Nov 2019 10:54)
  • Costly default and skewed business cycle. (deposited 25 Feb 2021 09:40) [Currently Displayed]