Overborrowing and systemic externalities in the business cycle

Javier Bianchi

No 2009-24, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: Credit constraints that link a private agent?s debt to market-determined prices embody a credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to overborrow. The externality arises because agents fail to internalize the debt-deflation effects of additional borrowing when negative income shocks trigger the credit constraint. We quantify the effects of this inefficiency in a two-sector dynamic stochastic general equilibrium model of a small open economy calibrated to emerging markets. The credit externality increases the probability of financial crises by a factor of seven and causes the maximum drop in consumption to increase by 10 percentage points.

Date: 2009
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
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Related works:
Journal Article: Overborrowing and Systemic Externalities in the Business Cycle (2011)
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2010)
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2009)
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2009)
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