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Credit search and credit cycles

Feng Dong (), Pengfei Wang () and Yi Wen ()

Economic Theory, 2016, vol. 61, issue 2, 215-239

Abstract: The supply and demand of credit are not always well aligned, as is reflected in the countercyclical excess reserve-to-deposit ratio and interest spread between the lending rate and the deposit rate. We develop a search-based theory of credit allocations to explain the cyclical fluctuations in both bank reserves and interest spread. We show that search frictions in the credit market can naturally explain the countercyclical bank reserves and interest spread, as well as generate endogenous business cycles driven primarily by the cyclical utilization rate of credit resources, as long conjectured by the Austrian school of the business cycle. In particular, we show that credit search can lead to endogenous local increasing returns to scale and variable capital utilization in a model with constant returns to scale production technology and matching functions, thus providing a microfoundation for the indeterminacy literature of Benhabib and Farmer (J Econ Theory 63(1):19–41, 1994 ) and Wen (J Econ Theory 81(1):7–36, 1998 ). Copyright Springer-Verlag Berlin Heidelberg 2016

Keywords: Search frictions; Credit utilization; Credit rationing; Self-fulfilling prophecy; Business cycles; E22; E32; G21 (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1007/s00199-015-0916-5

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