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The perils of credit booms

Author

Listed:
  • Feng Dong

    (Shanghai Jiao Tong University)

  • Jianjun Miao

    (Boston University
    Southwestern University of Finance and Economics
    Central University of Finance and Economics)

  • Pengfei Wang

    (Hong Kong University of Science and Technology)

Abstract

We present a dynamic general equilibrium model of production economies with adverse selection in the financial market to study the interaction between funding liquidity and market liquidity and its impact on business cycles. Entrepreneurs can take on short-term collateralized debt and trade long-term assets to finance investment. Funding liquidity can erode market liquidity. High funding liquidity discourages firms from selling their good long-term assets since these good assets have to subsidize lemons when there is information asymmetry. This can cause a liquidity dry-up in the market for long-term assets and even a market breakdown, resulting in a financial crisis. Multiple equilibria can coexist. Credit booms combined with changes in beliefs can cause equilibrium regime shifts, leading to an economic crisis or expansion.

Suggested Citation

  • Feng Dong & Jianjun Miao & Pengfei Wang, 2018. "The perils of credit booms," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(4), pages 819-861, December.
    • Handle: RePEc:spr:joecth:v:66:y:2018:i:4:d:10.1007_s00199-017-1076-6
    DOI: 10.1007/s00199-017-1076-6
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    References listed on IDEAS

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    Cited by:

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    3. Feng Dong & Zhiwei Xu & Yu Zhang, 2022. "Bubbly Bitcoin," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(3), pages 973-1015, October.
    4. Zehao Liu & Chengbo Xie, 2023. "Haircuts, interest rates, and credit cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(1), pages 69-109, July.
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    6. Zhifeng Cai & Feng Dong, 2021. "A Model of Secular Migration from Centralized to Decentralized Trade," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 201-244, July.
    7. Gokmen, Gunes & Morin, Annaig, 2021. "Investment shocks and inequality dynamics," Economic Modelling, Elsevier, vol. 94(C), pages 570-579.

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    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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