Credit Demand and Supply: A Two-Way Feedback Relation

44 Pages Posted: 6 Oct 2017

Date Written: September 27, 2017

Abstract

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

Albertazzi, Ugo and Esposito, Lucia, Credit Demand and Supply: A Two-Way Feedback Relation (September 27, 2017). Bank of Italy Temi di Discussione (Working Paper) No. 1134. Available at SSRN: https://ssrn.com/abstract=3048287 or http://dx.doi.org/10.2139/ssrn.3048287

Ugo Albertazzi

ECB -DG Monetary Policy ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Lucia Esposito (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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