Good News is Bad News: Leverage Cycles and Sudden Stops

Abstract

We show that a model with forecastable changes in future productivity and an occasionally-binding borrowing constraint can match a set of stylized facts about Sudden Stop events. “Good” news about future productivity raises current borrowing, increasing the probability that the constraint binds, and a sudden stop occurs, in future periods. During the sudden stop, output, consumption and investment fall substantially below trend, as they do in the data. Also consistent with data, the economy exhibits a boom period prior to the sudden stop, with output, consumption, and investment all above trend. co-authored with Ozge Akinci (Federal Reserve Board)