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Credit Constraints and Self-Fulfilling Business Cycles

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  • Zheng Liu
  • Pengfei Wang

Abstract

We argue that credit constraints not only amplify fundamental shocks, they can also lead to self-fulfilling business cycles. We study a model with heterogeneous firms, in which imperfect contract enforcement implies that productive firms face binding credit constraints, with the borrowing capacity limited by expected equity value. A drop in equity value tightens credit constraints and reallocates resources from productive to unproductive firms. Such reallocation reduces aggregate productivity, further depresses equity value, generating a financial multiplier. Aggregate dynamics are isomorphic to those in a representative-agent economy with increasing returns. For sufficiently tight credit constraints, the model generates self-fulfilling business cycles.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 6 (2014)
Issue (Month): 1 (January)
Pages: 32-69

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Handle: RePEc:aea:aejmac:v:6:y:2014:i:1:p:32-69

Note: DOI: 10.1257/mac.6.1.32
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  1. Wang, Pengfei & Wen, Yi, 2008. "Imperfect competition and indeterminacy of aggregate output," Journal of Economic Theory, Elsevier, Elsevier, vol. 143(1), pages 519-540, November.
  2. Gali Jordi, 1994. "Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand," Journal of Economic Theory, Elsevier, Elsevier, vol. 63(1), pages 73-96, June.
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  4. Susanto Basu & John G. Fernald, 1994. "Are apparent productive spillovers a figment of specification error?," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 463, Board of Governors of the Federal Reserve System (U.S.).
  5. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, Elsevier, vol. 25(3), pages 380-396, December.
  6. Aghion, Philippe & Angeletos, George-Marios & Banerjee, Abhijit & Manova, Kalina, 2010. "Volatility and growth: Credit constraints and the composition of investment," Scholarly Articles 12490636, Harvard University Department of Economics.
  7. Chang-Tai Hsieh & Peter Klenow, 2009. "Misallocation and Manufacturing TFP in China and India," Working Papers, Center for Economic Studies, U.S. Census Bureau 09-04, Center for Economic Studies, U.S. Census Bureau.
  8. Zheng Liu & Pengfei Wang & Tao Zha, 2011. "Land-price dynamics and macroeconomic fluctuations," Working Paper Series, Federal Reserve Bank of San Francisco 2011-26, Federal Reserve Bank of San Francisco.
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  10. Aghion, Philippe & Angeletos, George-Marios & Banerjee, Abhijit & Manova, Kalina, 2010. "Volatility and growth: Credit constraints and the composition of investment," Journal of Monetary Economics, Elsevier, Elsevier, vol. 57(3), pages 246-265, April.
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  15. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
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Cited by:
  1. Jianjun Miao & PENGFEI WANG, 2011. "Bubbles and Total Factor Productivity," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2011-030, Boston University - Department of Economics.
  2. John Fernald, 2014. "Productivity and Potential Output Before, During, and After the Great Recession," NBER Working Papers 20248, National Bureau of Economic Research, Inc.

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