Macroeconomic Effects of Leverage Cycles and Deleveraging

Abstract

This paper discusses the idea of the leverage cycle, the affect it has on the economy as a whole, and how it has shaped both ebullient and turbulent economic times. Leverage, simply being the ratio of collateral to equity, is virtually ignored by society and is unknown even to some economists. However, it has played a large role in both the Great Depression and the recession on the late 2000s. This paper analyzes some theory behind the leverage cycle, as well as looks at models meant to mathematically represent the leverage cycle. After reviewing that available literature on the subject, it goes on to describe the role of over-leverage during economic downturn, and then looks at the deleveraging events which follow. Finally, policy recommendations are presented on how to use leverage in moderation, and potentially prevent future crises.