Collateral, Credit History, and the Financial Decelerator

45 Pages Posted: 10 Nov 2005  

Ronel Elul

Federal Reserve Bank of Philadelphia

Multiple version iconThere are 2 versions of this paper

Date Written: September 2005

Abstract

We develop a simple model in which financial imperfections can serve to stabilize aggregate fluctuations and not merely aggravate them as in much of the previous literature; we term this a financial decelerator.

In our model agents borrow to purchase housing and secure their loans with this long-lived asset. There are two financial imperfections in this model. First, agents are unable to commit to repay their loans - that is, they can strategically default. This limits the amount that lenders are willing to offer. In addition, however, lenders are also imperfectly informed as to a borrower's propensity to default; that is, there is adverse selection. The latter imperfection implies that default may actually occur in equilibrium, unlike in much of the previous
literature.

For relatively high house prices the commitment problem ensures that the equilibrium is typically characterized by a standard financial accelerator; that is, the borrowing constraints which prevent default become tighter as falling prices reduce the wealth with which agents can collateralize future loans, thereby exacerbating aggregate fluctuations. However, we show that when prices are low, agents will default, which serves as a stabilizing force.

Keywords: Financial accelerator, Default, Collateral, Credit history

JEL Classification: D52, E44, G12, G21, G33

Suggested Citation

Elul, Ronel, Collateral, Credit History, and the Financial Decelerator (September 2005). FRB Philadelphia Working Paper No. 05-23. Available at SSRN: https://ssrn.com/abstract=839964 or http://dx.doi.org/10.2139/ssrn.839964

Ronel Elul (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
215-574-3965 (Phone)

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