TD n. 644 2015

Rodrigo Abreu, Tiago Couto Berriel.

This paper explores the interaction between a credit crunch and the maturity

of government debt, focusing on its impacts on an economy with heterogeneous

households. We nd that an increase in debt maturity helps softening the economic

slump that follows a credit crisis. We show that, immediately after the credit shock,

there is an output drop of nearly 1% when the asset available has on average one

quarter of maturity, while a contraction of only 0.6% follows when debt duration

has three quarters. The rise of asset duration indirectly enhances the income eects

unleashed by general equilibrium price dynamics, which benets bondholders and

thus softens the recession. On the other hand, an increase on debt duration impairs

the improvement of wealth distribution on the long run. The main contribution

this paper paper is to show that debt maturity is a key element to understand the

magnitude of a recession driven by credit and its welfare consequences.