Skip to main content
    • Aa
    • Aa


  • Marco Gross (a1), Jerome Henry (a2) and Willi Semmler (a2)

We investigate the consequences of overleveraging and the potential for destabilizing effects arising from financial- and real-sector interactions. In a theoretical framework, we model overleveraging and demonstrate how a highly leveraged banking system can lead to unstable dynamics and downward spirals. Inspired by models developed by Brunnermeier, Sannikov and Stein, we empirically measure the deviation-from-optimal-leverage for a sample of large EU banks. This measure of overleveraging is used to condition the joint dynamics of credit flows and macroeconomic activity in a large-scale regime change model: a Threshold Mixed-Cross-Section Global Vector Autoregressive (T-MCS-GVAR). The regime-switching component of the model is meant to make the relationship between credit and real activity dependent on the extent to which the banking system is overleveraged. We find significant nonlinearities as a function of overleverage. The farther the observed leverage in the banking system from optimal leverage, the more detrimental is the effect of a deleveraging shock on credit supply and economic activity.

Corresponding author
Address correspondence to: Willi Semmler, Henry Arnhold Professor of Economics, Department of Economics, New School for Social Research, New York, NY, USA; e-mail:
Linked references
Hide All

This list contains references from the content that can be linked to their source. For a full set of references and notes please see the PDF or HTML where available.

T. Adrian and H. S. Shin (2010) Liquidity and leverage. Journal of Financial Intermediation 19 (3), 418437.

F. Allen and D. Gale (2004) Financial intermediaries and markets. Econometrica 72 (4), 10231061.

B. S. Bernanke , M. Gertler and S. Gilchrist (1999) The financial accelerator in a quantitative business cycle framework. Handbook of Macroeconomics 1, 13411393.

M. K. Brunnermeier and Y. Sannikov (2014) A macroeconomic model with a financial Sector. American Economic Review 104 (2), 379421.

F. Canova and G. De Nicolo (2002) Monetary disturbances matter for business fluctuations in the G-7. Journal of Monetary Economics 49, 11311159.

S. Claessens , M. Kose and M. Terrones (2012) How do business and financial cycles interact? Journal of International Economics 87 (1), 178190.

S. Dees , F. di Mauro , M. H. Pesaran , and L. V. Smith (2007) Exploring the international linkages of the euro area: A global VAR analysis. Journal of Applied Econometrics 22 (1), 138.

J. Faust (1998) The robustness of identified VAR conclusions about money. Carnegie-Rochester Conference Series on Public Policy 49 (1), 207244.

J. Geanakoplos (2009) The leverage cycle. NBER Macroeconomics Annual 24, 165.

A. Gerali , S. Neri , L. Sessa and F. M. Signoretti (2010) Credit and banking in a DSGE model of the euro area. Journal of Money, Credit and Banking 42 (s1), 107141.

L. Gruene , W. Semmler and M. Stieler (2015) Using nonlinear model predictive control for dynamic decision problems in economics. Journal of Economic Dynamics and Control 60, 112133.

N. Kiyotaki and J. Moore (1997) Credit cycles. Journal of Political Economy 105 (2), 211248.

S. Mittnik and W. Semmler (2013) The real consequences of financial stress. Journal of Economic Dynamics & Control 37 (8), 14791499.

M. H. Pesaran , T. Schuermann and S. M. Weiner (2004) Modelling regional interdependencies using a global error-correcting macroeconometric model. Journal of Business and Economic Statistics 22 (2), 129162.

M. H. Pesaran and R. Smith (2006) Macroeconometric modeling with a global perspective. The Manchester School 74 (1), 2449.

M. Schularick and A. M. Taylor (2012) Credit booms gone bust: Monetary policy, leverage cycles, and financial crises, 1870–2008. American Economic Review 102 (2), 10291061.

J. L. Stein (2012) Stochastic Optimal Control and the U.S. Financial Debt Crisis. Heidelberg/New York: Springer.

H. Uhlig (2005) What are the effects of monetary policy on output? Results from an agnostic identification procedure. Journal of Monetary Economics 52 (2), 381419.

Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *



Full text views

Total number of HTML views: 0
Total number of PDF views: 6 *
Loading metrics...

Abstract views

Total abstract views: 19 *
Loading metrics...

* Views captured on Cambridge Core between 11th July 2017 - 25th July 2017. This data will be updated every 24 hours.