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Financial intermediation as a source of aggregate instability

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FABRIZIO MATTESINI

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Abstract

We consider a simple overlapping generations economy where the behavior of intermediaries, in a market characterized by asymmetric information and moral hazard, may give rise to cyclical equilibria. When capital increases output and savings also increase, and therefore more capital will be available in the following period. At the same time, however, interest rates also decrease and this induces intermediaries to reduce the amount of resources devoted to monitoring. A larger number of firms will select low quality projects and, because of this, less capital will be produced in the following period. For some parameter values this second effect may prevail over the first one and the stock of capital in period t+1 may actually be lower than the stock of capital in period t. The model provides a rigorous interpretation of the view associated with Hyman Minsky [14], Charles Kindleberger[12], and Henry Kaufman[11], according to which expansions come to an inevitable end because of excessive or ill-considered lending that took place during the boom.

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Paper provided by Tor Vergata University, CEIS in its series Departmental Working Papers with number 218.

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Date of creation: Sep 2005
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Handle: RePEc:rtv:ceiswp:218

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  1. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October. [Downloadable!] (restricted)
  2. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August. [Downloadable!] (restricted)
  3. Henry Kaufman, 1986. "Debt: the threat to economic and financial stability," Economic Review, Federal Reserve Bank of Kansas City, issue Dec, pages 3-11. [Downloadable!]
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  5. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December. [Downloadable!] (restricted)
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  6. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 2000. "Capital Markets and the Instability of Open Economies," Working Papers 99.01 update, Swiss National Bank, Study Center Gerzensee. [Downloadable!]
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  7. Suarez, Javier & Sussman, Oren, 1997. "Endogenous Cycles in a Stiglitz-Weiss Economy," CEPR Discussion Papers 1604, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March. [Downloadable!] (restricted)
  9. Cars H. Hommes, 2001. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," Tinbergen Institute Discussion Papers 01-014/1, Tinbergen Institute. [Downloadable!]
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  10. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-47, May. [Downloadable!] (restricted)
  11. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers 343, Banca Italia - Servizio di Studi.
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  12. Pomerleano, Michael, 1998. "The East Asia crisis and corporate finances : the untold micro story," Policy Research Working Paper Series 1990, The World Bank. [Downloadable!]
  13. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  14. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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  15. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  16. Henry Kaufman, 1986. "Debt: the threat to economic and financial stability," Proceedings, Federal Reserve Bank of Kansas City, pages 15-26.
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  18. Weiss, Lawrence A., 1990. "Bankruptcy resolution: Direct costs and violation of priority of claims," Journal of Financial Economics, Elsevier, vol. 27(2), pages 285-314, October. [Downloadable!] (restricted)
  19. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October. [Downloadable!] (restricted)
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