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Overborrowing and Systemic Externalities in the Business Cycle

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  • Javier Bianchi

Abstract

Credit constraints linking debt to market-determined prices embody a systemic credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to overborrow. This externality arises because private agents fail to internalize the financial amplification effects of carrying a large amount of debt when credit constraints bind. We conduct a quantitative analysis of this externality in a two-sector dynamic stochastic general equilibrium (DSGE) model of a small open economy calibrated to emerging markets. Raising the cost of borrowing during tranquil times restores constrained efficiency and significantly reduces the incidence and severity of financial crises. (JEL: E13, E32, E44, F41, G01)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 101 (2011)
Issue (Month): 7 (December)
Pages: 3400-3426

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Handle: RePEc:aea:aecrev:v:101:y:2011:i:7:p:3400-3426

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. About overborrowing
    by Christian Zimmermann in NEP-DGE blog on 2009-11-01 02:26:03
  2. Capital Controls, Currency Wars, and International Cooperation
    by Blog Author in Liberty Street Economics on 2013-05-13 11:00:00
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