Abstract:We ask two questions related to how access to credit aects the nature of business cycles.
First, does the standard theory of unsecured credit account for the high volatility and procycli-
cality of credit and the high volatility and countercyclicality of bankruptcy lings found in U.S.
data? Yes, it does, but only if we explicitly model recessions as displaying countercyclical earnings
risk (i.e., rather than having all households fare slightly worse than normal during recessions, we
ensure that more households than normal fare very poorly). Second, does access to credit smooth
aggregate consumption or aggregate hours worked, and if so, does it matter with respect to the
nature of business cycles? No, it does not, in fact consumption is 20 percent more volatile when
credit is available. The interest rate premia increase in recessions because of higher bankruptcy
risk discouraging households from using credit. This nding contradicts the intuition that access
to credit helps households to smooth their consumption.