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Real Credit Cycles

Author

Listed:
  • Pedro Bordalo
  • Nicola Gennaioli
  • Andrei Shleifer
  • Stephen J. Terry

Abstract

We embed diagnostic expectations in a workhorse neoclassical model with heterogeneous firms and risky debt. A realistic degree of overreaction estimated from US firms' earnings forecasts generates realistic credit cycles. Good times produce economic and financial fragility, predicting future disappointment of expectations, low bond returns, and investment declines. To generate the size of spread increases observed during 2007–2009, the model requires only moderate negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.

Suggested Citation

  • Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer & Stephen J. Terry, 2026. "Real Credit Cycles," American Economic Review, American Economic Association, vol. 116(4), pages 1274-1308, April.
    • Handle: RePEc:aea:aecrev:v:116:y:2026:i:4:p:1274-1308
    DOI: 10.1257/aer.20211820

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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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