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Stability or restructuring? Macroeconomic dynamics under soft budget constraint problems

  • Toyofuku, Kenta
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    In this paper, we examine how a decrease in firms’ productivity or the degree of financial market imperfection affects macroeconomic dynamics when the bank has an incentive to misallocate its credit. We develop a model that incorporates a soft budget constraint into a simplified version of Kiyotaki and Moore (1997) environment and show that soft budget constraint problems may arise if the economy becomes less productive or the financial market is less developed. Because of this shift in firms’ productivity, not only do more bad projects survive, but profitable new entrants are crowded out, so that, as in transition economies and Japan in the 1990s, the recession is not only prolonged, but also becomes more severe in the long term.

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    Article provided by Elsevier in its journal Economic Systems.

    Volume (Year): 37 (2013)
    Issue (Month): 4 ()
    Pages: 625-649

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    Handle: RePEc:eee:ecosys:v:37:y:2013:i:4:p:625-649
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    7. Brandt, Loren & Zhu, Xiaodong, 2001. "Soft budget constraint and inflation cycles: a positive model of the macro-dynamics in China during transition," Journal of Development Economics, Elsevier, vol. 64(2), pages 437-457, April.
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    22. Toyofuku, Kenta, 2008. "Soft budget constraints, bank capital, and the monetary transmission mechanism," Japan and the World Economy, Elsevier, vol. 20(2), pages 194-216, March.
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