Credit Demand and Supply: A Two-Way Feedback Relation
44 Pages Posted: 6 Oct 2017
Date Written: September 27, 2017
The model developed in this paper extends the framework of self-fulfilling credit market freezes proposed by Bebchuk and Goldstein (2011) by endogenizing firms' investments decisions. The existence of an aggregate investment threshold below which individual investment projects are unsuccessful creates a coordination failure not only among banks but also among firms and, crucially, between the two sides of the market. Because of the resulting strategic complementarities between firms and banks, low credit demand expectations reduce credit supply and viceversa. This two-way feedback loop explains why a severe slump in aggregate demand may be associated with a disruption in lending caused by a financial crisis. Replies to the euro area Bank Lending Survey by individual Italian banks provide support to the model's conclusions.
Keywords: credit crunch, investment, strategic complementarities, global games
JEL Classification: D25, D82, E51, G21
Suggested Citation: Suggested Citation