Overborrowing and Systemic Externalities in the Business Cycle
- (pp. 3400-3426)
Abstract
Credit constraints linking debt to market-determined prices embody a systemic credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to overborrow. This externality arises because private agents fail to internalize the financial amplification effects of carrying a large amount of debt when credit constraints bind. We conduct a quantitative analysis of this externality in a two-sector dynamic stochastic general equilibrium (DSGE) model of a small open economy calibrated to emerging markets. Raising the cost of borrowing during tranquil times restores constrained efficiency and significantly reduces the incidence and severity of financial crises. (JEL: E13, E32, E44, F41, G01)Citation
Bianchi, Javier. 2011. "Overborrowing and Systemic Externalities in the Business Cycle." American Economic Review, 101 (7): 3400-3426. DOI: 10.1257/aer.101.7.3400Additional Materials
JEL Classification
- E13 General Aggregative Models: Neoclassical
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
- F41 Open Economy Macroeconomics
- G01 Financial Crises