Interest Rate Dynamics, Variable-Rate Loan Contracts, and the Business Cycle

Patrick Pintus, Yi Wen and Xiaochuan Xing

No 2015-32, Working Papers from Federal Reserve Bank of St. Louis

Abstract: The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates forecast booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when business-cycle movements are driven, in a significant way, by animal spirit shocks to credit-financed investment demand. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the loan has a variable-rate component. In addition, Bayesian estimation of our benchmark DSGE model on US data 1975-2010 shows that movements in investment driven by animal spirits are quantitatively important and result in a better fit to the data than both standard RBC models and Kiyotaki-Moore type models with unique equilibrium.

Keywords: Endogenous Borrowing Constraints; Collateral; Variable-Rate Loans; Multiple Equilibria; sunspot shocks (search for similar items in EconPapers)
JEL-codes: E21 E22 E32 E44 E63 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2015-09-01
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (2)

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DOI: 10.20955/wp.2015.032

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