Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/297402 
Year of Publication: 
2023
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2023-17
Publisher: 
Bank of Canada, Ottawa
Abstract: 
We study an economy with a time-varying distribution of production to examine the role of debt in amplifying and propagating recessions. In our model, entrepreneurs use risky, long-term debt to finance capital. Liquid assets serve as collateral and transaction costs make debt illiquid. Debt payments increase the volatility of earnings relative to output, deterring entrepreneurs with insufficient collateral from financing efficient levels of capital. This results in a misallocation of resources. In a large recession, productive entrepreneurs with high levels of debt deleverage, amplifying the downturn. The model economy exhibits asymmetries over the business cycle. Recessions involve a rapid deterioration of economic activity, while expansions are more gradual. When a recession coincides with a rise in leverage resulting from a fall in assets, fewer producers operate at efficient levels. When the aggregate business leverage is ten percentage points above average, the half-life of the recovery doubles.
Subjects: 
Business fluctuations and cycles
Firm dynamics
Productivity
JEL: 
E23
E30
E32
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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