Working Paper（24-004E）Asset Price Booms and Macroeconomic Debt Overhang

We propose a tractable model of financial crises to demonstrate that corporate debt restructuring can promote economic recovery. The model can replicate the following empirical regularities: Credit-fueled asset-price booms end up with collapses, followed by deep and persistent recessions with productivity declines. Risk-shifting firms amplify the booms and busts of asset prices by purchasing the assets by borrowed money. Resultant debt overhang lowers productivity and output by discouraging borrowing firms from expending additional efforts. This inefficiency is aggravated by the spillover effect in the monopolistic competition. Larger asset-price booms are followed by deeper and more persistent recessions. The ex-post government subsidy to lenders for implementing debt relief can improve the borrowers' productivity and increase the lenders' payoff and social welfare, without inducing time inconsistency.

* The previous title of this paper was "Asset-Price Collapse and Macroeconomic Debt Overhang."

Key words: Financial crisis, love-for-variety, zombie lending, the debt Laffer curve.

Revised September 2 2024