Credit Enforcement Cycles
Lukasz Drozd and
No 17-27, Working Papers from Federal Reserve Bank of Philadelphia
Empirical evidence suggests that widespread financial distress, by disrupting enforcement of credit contracts, can be self-propagatory and adversely affect the supply of credit. We propose a unifying theory that models the interplay between enforcement, borrower default decisions, and the provision of credit. The central tenets of our framework are the presence of capacity constrained enforcement and borrower heterogeneity. We show that, despite heterogeneity, borrowers tend to coordinate their default choices, leading to fragility and to credit rationing. Our model provides a rationale for the comovement of enforcement, default rates and credit seen in the data.
Keywords: contract enforcement; enforcement capacity; default spillovers; credit crunch; credit cycles; global games; heterogeneity (search for similar items in EconPapers)
JEL-codes: D82 D84 D86 G21 O16 O17 O43 (search for similar items in EconPapers)
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