Debt and Macroeconomic Stability: Debt and the Business Cycle

Using a large panel of OECD countries this paper studies the link between debt and macroeconomicstability by comparing the evolution of balance sheet aggregates and economic output in high- and lowdebtenvironments. While the relationship between debt and economic growth has been extensively studiedin the literature, only little attention has been paid to the impact of debt on volatility and higher momentsof output growth distributions. This paper fills in this gap. Debt-fuelled expansions are found to typicallylast longer but to culminate in a more sizeable downturn. The greater amplitude of business cycles inhigh-debt environments reflects higher macroeconomic volatility but also higher tail risks and adverseasymmetries in output growth distributions. The induced welfare losses justify policy interventions aimingat preventing excessive build-ups in debt ex-ante.