Overborrowing, Deleveraging and a Great Recession

This paper examines the role of overborrowing, deleveraging, and an incomplete nancial market in driving an economy to a great recession with a binding zero lower bound on the nominal interest rate (ZLB). There are two key features that dierentiate my work from the current literature of deleveraging and the ZLB. First, I endogenize the debt limit of borrowers by tying it to the market value of collateral assets. Second, and more importantly, I allow for overborrowing by calibrating the model to match with the high debt-to-income ratio at the onset of the Great Recession for the U.S. homeowners that owned a house in 1997. I am able to show that the second feature makes the ZLB more likely to bind under an adverse shock to the credit market. When the ZLB binds, a great recession emerges with a free fall in output and the price level, mostly due to the Fisherian debt deation