Sustainable Financial Obligations and Crisis Cycles

23 Pages Posted: 10 May 2011

See all articles by Mikael Juselius

Mikael Juselius

Bank for International Settlements (BIS) - Monetary and Economic Department; Hanken School of Economics - Department of Economics; University of Helsinki - Department of Political and Economic Studies

Moshe Kim

University of Haifa - Department of Economics

Date Written: May 4, 2011

Abstract

What level of indebtedness jeopardizes economic stability? We show that the ratio of financial obligations (interest payments and amortizations) to income is crucial for capturing debt sustainability. Estimating a regime-switching model on aggregate US data, we find that credit losses become highly sensitive to adverse shocks when household or business sector financial obligations ratios exceed threshold values of 10%. This occurs 1-2 years prior to each economic downturn in our sample, 1985Q1-2010Q2, indicating that excessive debt has a significant effect on the business cycle. Our results have implications for macroprudential policy and the design of countercyclical capital buffers for banks.

Keywords: Debt sustainability, credit losses, financial crises, leverage, financial obligations, regime-switching model, smooth transition regression

JEL Classification: E32, E44, G01, G21

Suggested Citation

Juselius, Mikael and Kim, Moshe, Sustainable Financial Obligations and Crisis Cycles (May 4, 2011). Available at SSRN: https://ssrn.com/abstract=1831262 or http://dx.doi.org/10.2139/ssrn.1831262

Mikael Juselius (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Hanken School of Economics - Department of Economics ( email )

PO Box 479
FI-00101 Helsinki
Finland

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland

Moshe Kim

University of Haifa - Department of Economics ( email )

Haifa 31905
Israel
(972) 4 8240115 (Phone)
(972)4-8240059 (Fax)

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