Credit Constraints and Self-Fulfilling Business Cycles
- (pp. 32-69)
AbstractWe argue that credit constraints not only amplify fundamental shocks, they can also lead to self-fulfilling business cycles. We study a model with heterogeneous firms, in which imperfect contract enforcement implies that productive firms face binding credit constraints, with the borrowing capacity limited by expected equity value. A drop in equity value tightens credit constraints and reallocates resources from productive to unproductive firms. Such reallocation reduces aggregate productivity, further depresses equity value, generating a financial multiplier. Aggregate dynamics are isomorphic to those in a representative-agent economy with increasing returns. For sufficiently tight credit constraints, the model generates self-fulfilling business cycles.
CitationLiu, Zheng, and Pengfei Wang. 2014. "Credit Constraints and Self-Fulfilling Business Cycles." American Economic Journal: Macroeconomics, 6 (1): 32-69. DOI: 10.1257/mac.6.1.32
- E13 General Aggregative Models: Neoclassical
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
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