The theory that rich economic diversity of businesses and households both affects and is shaped by economy-wide fluctuations has strong implications for monetary policy. This review places these insights in a Canadian context.
A large-scale reduction in mortgage principal can strengthen a recovery, support house prices and lower foreclosures. The nature of the intervention shapes its impact, which rests on how resources are redistributed across households. The availability of bankruptcy on unsecured debt changes the response to large-scale mortgage relief by reducing precautionary savings.
We examine the role of debt in amplifying and propagating recessions. Firms’ debt adjustment makes recessions deeper but makes expansions gradual. In particular, when the aggregate business leverage is ten percentage points above average, the half-life of the recovery doubles.
Models with default options are hard to solve. We propose an extension of the endogenous grid method that solves default risk models more efficiently and accurately.
