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Equilibrium Lending Mechanism and Aggregate Activity

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  • Wang, Cheng
  • Zhou, Ruilin

Abstract

What determines the firm's choice of its mechanism of investment financing? How is the choice of the firm's financing mechanism at the micro level related to the economy's business cycle movements at the aggregate level? This paper develops a model of the credit market where the equilibrium lending mechanism, as well as the economy's aggregate investment and output, are endogenously determined. Among other things, our model predicts that a negative productivity shock can cause an economic downturn that is accompanied not only by a contraction in total outstanding loans, but also by a decline in the ratio of bank loans to non-bank lending, as observed in the 1990-91 U.S. recession.

Suggested Citation

  • Wang, Cheng & Zhou, Ruilin, 2004. "Equilibrium Lending Mechanism and Aggregate Activity," Staff General Research Papers Archive 12037, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genres:12037
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