Real Credit Cycles

Pedro Bordalo; Nicola Gennaioli; Andrei Shleifer; Stephen J. Terry

doi:10.3386/w28416

Real Credit Cycles

Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer & Stephen J. Terry

Working Paper 28416

DOI 10.3386/w28416

Issue Date January 2021

Revision Date December 2021

We incorporate diagnostic expectations into a workhorse neoclassical business cycle model with heterogeneous firms and risky debt. A realistic degree of diagnostic overreaction estimated from US firm forecasts generates economic fragility during good times, countercyclical credit spreads, and boom-bust credit cycles at the firm and aggregate levels. Good times predict future disappointment, spread increases, low bond returns, and investment declines. To generate the size of spread increases observed during 2008-9, the model requires only disappointment of overoptimistic beliefs rather than large negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.

We thank audiences at FRB Minneapolis, Yale Finance, Harvard Business School Finance, NBER Behavioral Macro, Northwestern Kellogg Finance, Stanford SITE Uncertainty, NHH, the European Central Bank, Boston University, Harvard Economics, University of Oregon, University of Virginia Darden, NBER Impulse and Propagation Mechanisms, FRB Chicago, AEAs, Queen Mary University of London, Econometric Society, Green Line Macro Meeting, Dartmouth Macro Mini-Conference, CREi-UPF, and the Macro Finance Society, our discussants Alp Simsek, Cosmin Ilut, Ryan Chahrour, and Stefan Niemann, as well as Spencer Kwon, for valuable comments and suggestions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
MARC RIS BibTeΧ
- January 27, 2021

Real Credit Cycles

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