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Good and Bad Investment: An Inquiry into the Causes of Credit Cycles

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  • Kiminori Matsuyama

    (Department of Economics, Northwestern University and CIRJE, Faculty of Economics, University of Tokyo)

Abstract

This 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 Info

Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-172.

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Length: 52 pages
Date of creation: Sep 2002
Date of revision:
Handle: RePEc:tky:fseres:2002cf172

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  1. Piketty, Thomas & Banerjee, Abhijit & Aghion, Philippe, 1999. "Dualism and Macroeconomic Volatility," Scholarly Articles 4554124, Harvard University Department of Economics.
  2. Matsuyama, Kiminori, 2001. "Growing through Cycles in an Infinitely Lived Agent Economy," Journal of Economic Theory, Elsevier, vol. 100(2), pages 220-234, October.
  3. Matsuyama, Kiminori, 1996. "Growing Through Cycles," Economics Series 40, Institute for Advanced Studies.
  4. Matsuyama, Kiminori, 2000. "Endogenous Inequality," Review of Economic Studies, Wiley Blackwell, vol. 67(4), pages 743-59, October.
  5. 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.
  6. Azariadis, Costas & Smith, Bruce, 1998. "Financial Intermediation and Regime Switching in Business Cycles," American Economic Review, American Economic Association, vol. 88(3), pages 516-36, June.
  7. Kiminori Matsuyama, 2000. "Financial Market Globalization and Endogenous Inequality of Nations," Discussion Papers 1300, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. Michele Boldrin & Michael Woodford, 1988. "Equilibruim Models Displaying Endogenous Fluctuations and Chaos: A Survey," UCLA Economics Working Papers 530, UCLA Department of Economics.
  9. Baumol, William J & Benhabib, Jess, 1989. "Chaos: Significance, Mechanism, and Economic Applications," Journal of Economic Perspectives, American Economic Association, vol. 3(1), pages 77-105, Winter.
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Cited by:
  1. Kiminori Matsuyama, 2004. "Credit Market Imperfections and Patterns of International Trade and Capital Flows," CIRJE F-Series CIRJE-F-293, CIRJE, Faculty of Economics, University of Tokyo.
  2. Gersbach, Hans & Wenzelburger, Jan, 2005. "Do Risk Premia Protect from Banking Crises?," CEPR Discussion Papers 4935, C.E.P.R. Discussion Papers.
  3. Takuma Kunieda & Akihisa Shibata, 2003. "Credit Constraints and the Current Account: A Test for the Japanese Economy," KIER Working Papers 573, Kyoto University, Institute of Economic Research.

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