Credit Market Development, Economic Performance and Business Cycle Volatility

This paper studies the role of credit market development in an economy with credit frictions. I examine how the provision of credit in connection with collateral assets affects both economic performance and business cycle volatility. First, I analyse the macroeconomic implications of an improvement in the tinancial market that allows for a higher degree of access to the credit market. Then, I study how different levels of credit market development affect the vulnerability of the economy to major adverse shocks. This paper sheds light on the trade off between efficiency and stability over the business cycle. In the framework of an economy in which credit contraints arise because borrowers cannot force lenders to repay, I show that, as expected, facilitating collateralized dept financing implies an increase in efficiency in terms of production. Moreover, I also show how the rise in collateral/asset prices is a direct consequence of credit markek development. Last, but most intriguing I demonstrate that the higher output volatility over the business cycle is associated with an higher degree of access to the credit market.