Overborrowing and Systemic Externalities in the Business Cycle

Javier Bianchi

MPRA Paper from University Library of Munich, Germany

Abstract: Credit constraints that link a private agent's debt to market-determined prices embody a systemic credit externality that drives a wedge between competitive and (constrained) socially optimal equilibria, which induces private agents to ``overborrow". We quantify the effects of this externality in a two-sector DSGE model of a small open economy calibrated to emerging markets. Debt is denominated in units of tradable goods, and is constrained not to exceed a fraction of income, including nontradables income valued at the relative price of nontradables. The externality arises because agents fail to internalize the price effects of their individual borrowing, and hence the adverse debt-deflation amplification effects of negative income shocks that trigger a binding credit constraint. Quantitatively, the credit externality causes a modest increase in average debt, of about 2 percentage points of GDP, but it triples the probability of financial crises and doubles the average current account and consumption reversals caused by these crises.

Keywords: Financial Crises; Business Cycles; Amplification Effects; Sudden Stops; Systemic Externalities (search for similar items in EconPapers)
JEL-codes: D62 E32 F20 F30 F32 F41 (search for similar items in EconPapers)
Date: 2009-04-28
New Economics Papers: this item is included in nep-bec and nep-dge
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/16270/1/MPRA_paper_16270.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/16271/1/MPRA_paper_16271.pdf revised version (application/pdf)

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)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:16270

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().