Self-Fulfilling Credit Market Freezes

Lucian Bebchuk () and Itay Goldstein

No 16031, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, with their success depending on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of alternative measures for getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, infusion of capital into banks, direct lending to operating firms by the government, and the provision of government capital or guarantees to finance or encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the financial crisis of 2008-2009.

JEL-codes: D21 E44 E58 E62 G18 G21 G28 (search for similar items in EconPapers)
Date: 2010-05
Note: CF EFG LE ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published as “Self - Fulfilling Credit Market Freezes,” 24 Review of Financial Studies 3519 - 3555 (2011) 24242321 . (with Itay Goldstein)

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