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  3. American Economic Review
  4. December 2011
  5. Overborrowing and Systemic Externalities in the Business Cycle

Overborrowing and Systemic Externalities in the Business Cycle

  • Javier Bianchi
American Economic Review
vol. 101, no. 7, December 2011
(pp. 3400-3426)
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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.101.7.3400

Additional 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