Self-Fulfilling Credit Cycles

63 Pages Posted: 19 Aug 2015 Last revised: 6 Mar 2019

See all articles by Costas Azariadis

Costas Azariadis

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Leo Kaas

University of Konstanz - Faculty of Economics and Statistics; IZA Institute of Labor Economics

Yi Wen

Federal Reserve Bank of St. Louis - Research Department; Tsinghua University

Multiple version iconThere are 3 versions of this paper

Date Written: 2015-03-20

Abstract

In U.S. data 1981–2012, unsecured firm credit moves procyclically and tends to lead GDP, while secured firm credit is acyclical; similarly, shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. In this paper we develop a tractable dynamic general equilibrium model in which unsecured firm credit arises from self-enforcing borrowing constraints, preventing an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation which is a forward-looking variable. We argue that self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated sunspot shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity and output. We show that these sunspot shocks are quantitatively important, accounting for around half of output volatility.

Keywords: Unsecured firm credit, Credit cycles, Sunspots

JEL Classification: D92, E32

Suggested Citation

Azariadis, Costas and Kaas, Leo and Wen, Yi, Self-Fulfilling Credit Cycles (2015-03-20). FRB St. Louis Working Paper No. 2015-5. Available at SSRN: https://ssrn.com/abstract=2646144

Costas Azariadis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Leo Kaas

University of Konstanz - Faculty of Economics and Statistics ( email )

Universitaetsstr. 10
78457 Konstanz
Germany

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Yi Wen

Federal Reserve Bank of St. Louis - Research Department ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8559 (Phone)
314-444-8731 (Fax)

Tsinghua University ( email )

Beijing, 100084
China

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