A Behavioral Model of the Credit Cycle
46 Pages Posted: 7 Nov 2018
Date Written: October 30, 2018
In a behavioral variant of a New Keynesian model, in which individuals use simple heuristic rules to forecast future inflation and output gap, if there are limits on the amount of debt that economic agents are allowed to bear, we observe occasionally severe downturns. Differences in beliefs combined with borrowing constraints tend to dampen expansions, but give rise to a chain reaction that exacerbates the recessions. The model is an example of endogenous credit cycles with expansions, severe recessions, and persistent inequality in the distribution of wealth. Monetary policy can both stabilize the economy and cause increased average output.
Keywords: Credit cycle, heuristic rules, monetary policy
JEL Classification: E10, E32, D83.
Suggested Citation: Suggested Citation