Article2017

Uncertainty Shocks and Balance Sheet Recessions

159 citations0/0 files storedJournal of Political Economy

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Economic theories and models Monetary Policy and Economic Impact Economic Theory and Policy

Abstract

This paper investigates the origin and propagation of balance sheet recessions. I first show that in standard models driven by TFP shocks, the balance sheet channel disappears when agents can write contracts on the aggregate state of the economy. Optimal contracts sever the link between leverage and aggregate risk sharing, eliminating the concentration of aggregate risk that drives balance sheet recessions. I then show that uncertainty shocks can help explain this concentration of aggregate risk and drive balance sheet recessions, even with contracts on aggregate shocks. The mechanism is quantitatively important, and I explore implications for financial regulation.

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References

1973An Intertemporal Capital Asset Pricing Model 2009The Impact of Uncertainty Shocks 1997Credit Cycles 1999By Force of Habit: A Consumption‐Based Explanation of Aggregate Stock Market Behavior 2008Market Liquidity and Funding Liquidity 1998The Financial Accelerator in a Quantitative Business Cycle Framework 1988Agency Costs, Net Worth, And Business Fluctuations 2000Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles

Cited by

2020A Risk-Centric Model of Demand Recessions and Speculation*2023A Macro-Finance Model with Sentiment 2026Sovereign Debt, Domestic Banks, and the Provision of Public Liquidity 2020Risk, uncertainty, and leverage 2019Optimal Regulation of Financial Intermediaries 2021Heterogeneous intermediary asset pricing 2021Why Are Banks Exposed to Monetary Policy?

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