Credit Market and Macroeconomic Volatility
49 Pages Posted: 11 Apr 2007
Date Written: March 2007
This paper investigates the role of credit market size as a determinant of business cycle fluctuations. First, using OECD data I document that credit market depth mitigates the impact of variations in productivity to output volatility. Then, I use a business cycle model with borrowing limits a la Kiyotaki and Moore (1997) to replicate this empirical regularity. The relative price of capital and the reallocation of capital are the key variables in explaining the relation between credit market size and output volatility. The model matches resonably well the reduction in productivity-driven output volatility implied by the established size of the credit market observed in OECD data.
Keywords: credit frictions, reallocation of capital, asset prices
JEL Classification: E21, E22, E44, G20
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