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Deleveraging after the burst of a credit-bubble

By , ,

We present the results of an empirical exercise in which we seek to explain the deleveraging process that follows the burst of a credit bubble following a systemic banking crisis. We have built up two new databases and have estimated a SUR regression model to jointly explain and predict how strong and how fast private leverage falls after the burst of a credit-bubble.


What happens to private leverage after the bursting of a banking-crisis-inducing credit-bubble? The obvious answer would be simply that it falls. But the international experience shows that the process and consequences of a systemic banking crisis (including those preceded or accompanied by credit bubbles) are actually quite heterogeneous across different countries and even across different crises within the same country. Some recent literature has concentrated on the effects of a banking crisis on economic activity, but few studies have explored the deleveraging process itself.

How hard private leverage falls, how fast and what factors determine how severe is such a deleveraging process? In this study we explore some tentative answers to these questions. In order to do this we assemblage a rich database on the macro-financial dynamic preceding and following events of simultaneous occurrence of credit-bubbles and systemic banking crises, and used it in the estimation of a simultaneous equation econometric model able to explain and forecast the deleveraging dynamic conditioned to kind of events.

According to our results, the main determinants of the severity and speed of a deleveraging process after the burst of a credit-bubble (following a banking crisis) are the growth rate of the credit ratio during the boom period and the fiscal position of the country at the peak of the credit boom, while the external position plays a more limited role.

 

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