American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Real Credit Cycles
American Economic Review
(pp. 1274–1308)
Abstract
We embed diagnostic expectations in a workhorse neoclassical model with heterogeneous firms and risky debt. A realistic degree of overreaction estimated from US firms' earnings forecasts generates realistic credit cycles. Good times produce economic and financial fragility, predicting future disappointment of expectations, low bond returns, and investment declines. To generate the size of spread increases observed during 2007–2009, the model requires only moderate negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.Citation
Bordalo, Pedro, Nicola Gennaioli, Andrei Shleifer, and Stephen J. Terry. 2026. "Real Credit Cycles." American Economic Review 116 (4): 1274–1308. DOI: 10.1257/aer.20211820Additional Materials
JEL Classification
- D84 Expectations; Speculations
- E13 General Aggregative Models: Neoclassical
- E22 Investment; Capital; Intangible Capital; Capacity
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
- G12 Asset Pricing; Trading Volume; Bond Interest Rates
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill