Credit Frictions, Collateral and the Cyclical Behaviour of the Finance Premium
AbstractThis paper examines the behaviour of the finance premium following technology and monetary shocks in a Dynamic Stochastic General Equilibrium (DSGE) model where borrowers use a fraction of their production (output) as collateral. We show that this simple framework is capable of producing a countercyclical finance premium, while matching the macro dynamics of well-documented stylized facts. A key feature is the endogenous derivation of the default probability from break even conditions, that results in the loan rate being set as a countercyclical finance premium over the cost of borrowing from the central bank. The latter is shown to provide an accelerator effect through which shocks can amplify the loan spread and the dynamic response of macro variables.
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Bibliographic InfoPaper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 172.
Length: 20 pages
Date of creation: 2012
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-16 (All new papers)
- NEP-BAN-2012-09-16 (Banking)
- NEP-DGE-2012-09-16 (Dynamic General Equilibrium)
- NEP-MAC-2012-09-16 (Macroeconomics)
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