Debt and Depth of Recessions

Donghyun Park,Kwanho Shin,Shu Tian

doi:10.2139/ssrn.3590146

Abstract

This paper empirically investigates the relationship between the speed of buildup of private debt (household and corporate) and the depth of recessions. To do this, we differentiate between financial recessions and normal recessions on the basis of how quickly their private debt builds up. In addition to output recessions, we look at consumption and investment recessions. We find that financial recessions are deeper than normal recessions in advanced economies—and the differences become even more pronounced when emerging market economies are added to the sample. Our evidence suggests that a buildup in corporate debt is especially damaging for emerging markets during financial recessions. A higher ratio of debt to gross domestic product—in other words, less fiscal space—exacerbates recessions only beyond a certain threshold level, suggesting a nonlinear effect. We find that the buildup of corporate debt—and not just household debt—can worsen recessions, especially in emerging market economies.

Highlights

The Great Recession triggered by the global financial crisis (GFC) underlines the danger of recessions driven by financial crises
When we further distinguish between financial recessions that are driven by household rather than corporate debt buildups, we find that recessions driven by household debt buildups are generally deeper than those driven by corporate debt buildups in advanced economies (AEs), a finding in line with the literature
This paper empirically investigates the relationship between the buildup of private debt, which consists of household debt and corporate debt, and the depth of recessions

Summary

INTRODUCTION

The Great Recession triggered by the global financial crisis (GFC) underlines the danger of recessions driven by financial crises. For AEs, financial recessions are deeper at statistically significant levels than normal recessions for output and investment, but not for consumption. If EMEs are included in the sample, the difference in the severity of financial and normal recessions is larger for output and investment, and becomes statistically significant even for consumption in some specifications. These findings are generally true and even stronger when we use quartiles to define financial and normal recessions. The findings hold for financial recessions that do not coincide with crises These results indicate that private debt buildups can be even more damaging to EMEs, which have fewer instruments to smooth consumption.

DATA AND SUMMARY STATISTICS

EMPIRICAL METHODOLOGY

CONCLUSION

28 | Appendix