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Long-Term Debt, Default, and Firm-Targeted Stimulus during Severe Recessions (job market paper, draft available here)
A growing empirical literature suggests that the maturity risk associated with long-term debt reduces firm-level investment, particularly during recessions. I introduce discretely maturing long-term debt into a dynamic stochastic general equilibrium model where heterogeneous firms borrow subject to default risk. My model is distinguished relative to existing long-term debt models in that it captures the rollover risk arising from uncertainty about what economic conditions will be when debt matures. Moreover, my firms actively save in a short-term financial asset to help hedge against the maturity risk associated with their debt. Nonetheless, the rollover risk associated with discretely maturing long-term debt exacerbates the debt overhang problem arising in conventional long-term debt models. Thus, firms effectively face greater financial frictions, and output is on average lower. Consequently, my model predicts a larger rise in defaults and a greater decline in endogenous aggregate productivity in its response to a financial shock. Thus, its financial recessions are both deeper and longer-lived than in conventional models. I also consider a large non-financial aggregate shock, and use my model to study the efficacy of targeted stimulus policies implemented over the U.S. 2020 recession. My findings suggest that the combined effects of the Paycheck Protection Program and the expansion of quantitative easing helped stem the rise in defaults and stimulate the subsequent economic recovery.
We explore business cycles in overlapping generations economies wherein households, with uncertain lifetimes and uninsurable earnings when employed, face cyclical employment risk. Business cycles are driven by persistent shocks to TFP growth and household-level employment. Increases in employment risk cause fluctuations in the unemployment rate and the labor force. In this setting, we introduce elements commonly used to deliver a countercyclical price of risk in production economies. Specifically, households have non-separable utility characterized by high levels of risk aversion; a diminishing marginal productivity of investment leads to a time-varying price of capital.
High levels of precautionary savings characterize our model economy. We find that changes in precautionary savings, following aggregate shocks, have important implications for consumption. Persistent negative shocks to TFP growth, associated with increases in unemployment risk, drive large declines in consumption. This helps explain the slowdown observed since the onset of the Great Recession. An empirically consistent, moderate shock to TFP growth rates implies a large and persistent fall, against trend, in aggregate consumption. Moreover, a rise in households’ risk of long-term non-employment reduces labor force participation and reconciles the recovery in TFP growth rates with a protracted decline in consumption and output.
Works in Progress
Earnings Risk, Portfolio Heterogeneity, and the Racial Wealth Gap in the US
The Propagation Effects of Long-Term Debt Maturity on Business Cycles
Unconventional Monetary Policy over the Business Cycle