Good and Bad Investment: An Inquiry into the Causes of Credit Cycles
AbstractThis paper develops models of endogenous credit cycles. The basic model has two types of profitable investment projects: the Good and the Bad. Unlike the Good, the Bad contributes little to improve the net worth of other borrowers. Furthermore, it is relatively difficult to finance externally due to the agency problem. In a recession, a low net worth prevents the agents from financing the Bad, and much of the saving goes to finance the Good. This leads an improvement in net worth. In a boom, a high net worth makes it possible for the agents to finance the Bad. At the peak of the boom, this shift in the composition of credit and of investment from the Good to the Bad causes a deterioration of net worth, and the economy plunges into a recession. The whole process repeats itself. Endogenous fluctuations occur because the Good breeds the Bad, and the Bad destroys the Good. When extended to incorporate the Bernanke-Gertler (1989) type credit multiplier mechanism, the model generates asymmetric fluctuations, along which the economy experiences a long and slow process of recovery from a recession, followed by a rapid expansion, and possibly after a period of high volatility, plunges into a recession.
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Bibliographic InfoPaper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-172.
Length: 52 pages
Date of creation: Sep 2002
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Other versions of this item:
- Kiminori Matsuyama, 2001. "Good and Bad Investment: An Inquiry into the Causes of Credit Cycles," Discussion Papers 1335, Northwestern University, Center for Mathematical Studies in Economics and Management Science, revised Sep 2001.
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