University of Edinburgh - Economics; London School of Economics
London School of Economics & Political Science (LSE) - Department of Economics; National Bureau of Economic Research (NBER)
JOURNAL OF POLITICAL ECONOMY, Vol. 105, No. 2, April 1997
We construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets play a dual role: not only are they factors of production, but they also serve as collateral for loans. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors. We show that small, temporary shocks to technology or income distribution can generate large, persistent fluctuations in output and asset prices.
JEL Classification: E32, E37, E44
Date posted: April 28, 1997