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Overborrowing and Systemic Externalities in the Business Cycle

Javier Bianchi ()

No 96, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: Credit constraints that link a private agent's debt to market-determined prices embody a credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to ``overborrow." The externality arises because agents fail to internalize the price effects of additional borrowing when the credit constraint binds. We quantify the effects of this inefficiency in a two-sector DSGE model of a small open economy calibrated to emerging markets. The credit externality increases the probability of financial crises by a factor of 7 and causes the maximum drop in consumption to increase by 10 percentage points.

Date: 2010
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Related works:
Journal Article: Overborrowing and Systemic Externalities in the Business Cycle (2011) Downloads
Working Paper: Overborrowing and systemic externalities in the business cycle (2009) Downloads
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2009) Downloads
Working Paper: Overborrowing and Systemic Externalities in the Business Cycle (2009) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed010:96

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