Overborrowing and Systemic Externalities in the Business Cycle

Javier Bianchi

American Economic Review, 2011, vol. 101, issue 7, 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)

Date: 2011
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Related works:
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)
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2009)
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