Inefficient Credit Booms

Guido Lorenzoni ()

No 13639, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though, from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis.

JEL-codes: E32 E44 E61 G10 G18 (search for similar items in EconPapers)
Date: 2007-11
New Economics Papers: this item is included in nep-bec, nep-dge, nep-mac and nep-mon
Note: EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Published as Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Blackwell Publishing, vol. 75(3), pages 809-833, 07.

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Journal Article: Inefficient Credit Booms (2008)
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