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

We provide a tractable two-period model of financial crises that replicates empirical regularities that credit-fueled asset-price booms are often followed by the busts and deep and persistent recessions associated with productivity declines. We argue that the risk-shifting booms of asset prices tend to collapse, and resultant debt overhang lowers productivity and output by discouraging borrowers from expending efforts. This inefficiency is amplified by externality of a decrease in aggregate demand. Larger asset-price booms lead to deeper recessions. Ex-post government intervention to facilitate debt restructuring can be welfare improving, because it mitigates the demand externality and the associated time inconsistency may not have dominant effects.

Key words: Risk shifting, aggregate demand externality, financial crisis.