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The good, the bad, and the ugly: An inquiry into the causes and nature of credit cycles

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  • Matsuyama, Kiminori

    () (Department of Economics, Northwestern University)

Abstract

This paper builds models of nonlinear dynamics in the aggregate investment and borrower net worth to study the causes and nature of endogenous credit cycles. The basic model has two types of projects: the Good and the Bad. The Good projects rely on the inputs supplied by others who could undertake investment in the future, thereby improving their net worth. The Bad projects are independently profitable so that they do not improve the net worth of other borrowers. Furthermore, they are subject to the borrowing constraint due to some agency problems. With a low net worth, the agents cannot finance the Bad, and much of the credit goes to finance the Good, even when the Bad projects are more profitable than the Good projects. This over-investment to the Good creates a boom, leading to an improvement in borrower net worth. This makes it possible for the agents to finance the Bad. This shift in the composition of the credit from the Good to the Bad at the peak of the boom causes a deterioration of borrower net worth. The whole process repeats itself. Endogenous fluctuations occur, as the Good breed the Bad and the Bad destroy the Good. The model is then extended to add a third type of projects, the Ugly, which are unproductive but subject to no borrowing constraint. With a low net worth, the Good compete with the Ugly, which act as a drag on the Good, creating the credit multiplier effect. With a high net worth, the Good compete with the Bad, which destroy the Good, creating the credit reversal effect. By combining these two effects, this hybrid model generates intermittency phenomena, i.e., relatively long periods of small and persistent movements punctuated intermittently by seemingly random-looking behaviors. Along these cycles, the economy exhibits asymmetric fluctuations; it experiences a slow process of recovery from a recession, followed by a rapid expansion, and possibly after a period of high volatility, plunges into a recession.

Suggested Citation

  • Matsuyama, Kiminori, 2013. "The good, the bad, and the ugly: An inquiry into the causes and nature of credit cycles," Theoretical Economics, Econometric Society, vol. 8(3), September.
  • Handle: RePEc:the:publsh:1131
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    Cited by:

    1. Pablo A. Guerron-Quintana & Tomohiro Hirano & Ryo Jinnai, 2019. "Recurrent Bubbles and Economic Growth," CARF F-Series CARF-F-457, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    2. Kubin, Ingrid & Zörner, Thomas O. & Gardini, Laura & Commendatore, Pasquale, 2019. "A credit cycle model with market sentiments," Structural Change and Economic Dynamics, Elsevier, vol. 50(C), pages 159-174.
    3. Matteo Iacoviello & Raoul Minetti, 2006. "Liquidity Cycles," 2006 Meeting Papers 676, Society for Economic Dynamics.
    4. Nan‐Kuang Chen & Hung‐Jen Wang, 2007. "The Procyclical Leverage Effect Of Collateral Value On Bank Loans—Evidence From The Transaction Data Of Taiwan," Economic Inquiry, Western Economic Association International, vol. 45(2), pages 395-406, April.
    5. Felipe Iachan, 2012. "Liquidity Scarcity, Project Selection, and Volatility," 2012 Meeting Papers 480, Society for Economic Dynamics.
    6. Sushko, Iryna & Gardini, Laura & Matsuyama, Kiminori, 2014. "Superstable credit cycles and U-sequence," Chaos, Solitons & Fractals, Elsevier, vol. 59(C), pages 13-27.
    7. Takuma Kunieda & Akihisa Shibata, 2014. "Credit Market Imperfections and Macroeconomic Instability," Pacific Economic Review, Wiley Blackwell, vol. 19(5), pages 592-611, December.
    8. Kikuchi, Tomoo & Vachadze, George, 2015. "Financial liberalization: Poverty trap or chaos," Journal of Mathematical Economics, Elsevier, vol. 59(C), pages 1-9.
    9. Paul Beaudry & Dana Galizia & Franck Portier, 2017. "Is the Macroeconomy Locally Unstable and Why Should We Care?," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 479-530.
    10. Dong, Feng & Xu, Zhiwei, 2020. "Cycles of credit expansion and misallocation: The Good, the Bad and the Ugly," Journal of Economic Theory, Elsevier, vol. 186(C).
    11. Tiago Pinheiro & Francisco Rivadeneyra & Marc Teignier, 2017. "Financial Development, Credit, and Business Cycles," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(7), pages 1653-1665, October.
    12. Matsuyama, Kiminori & Sushko, Iryna & Gardini, Laura, 2016. "Revisiting the model of credit cycles with Good and Bad projects," Journal of Economic Theory, Elsevier, vol. 163(C), pages 525-556.
    13. Asano, Takao & Yokoo, Masanori, 2019. "Chaotic dynamics of a piecewise linear model of credit cycles," Journal of Mathematical Economics, Elsevier, vol. 80(C), pages 9-21.
    14. Kiminori Matsuyama, 2007. "Credit Traps and Credit Cycles," American Economic Review, American Economic Association, vol. 97(1), pages 503-516, March.
    15. Wai-Hong Ho, 2017. "Financial market globalization, nonconvergence and credit cycles," Annals of Finance, Springer, vol. 13(2), pages 153-180, May.
    16. Figueroa, Nicolás & Leukhina, Oksana, 2018. "Cash flows and credit cycles," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 318-332.
    17. Iryna Sushko & Laura Gardini & Kiminori Matsuyama, 2014. "Chaos in a Model of Credit Cycles with Good and Bad Projects," Working Papers 1405, University of Urbino Carlo Bo, Department of Economics, Society & Politics - Scientific Committee - L. Stefanini & G. Travaglini, revised 2014.
    18. Ivan Mendieta-Munoz, Doguhan Sundal, 2020. "Business cycles, financial conditions and nonlinearities," Working Paper Series, Department of Economics, University of Utah 2020_04, University of Utah, Department of Economics.
    19. Fukui, Masao, 2018. "Asset Quality Cycles," Journal of Monetary Economics, Elsevier, vol. 95(C), pages 97-108.
    20. Agliari, Anna & Rillosi, Francesco & Vachadze, George, 2015. "Credit market imperfection, financial market globalization, and catastrophic transition," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 108(C), pages 41-62.
    21. Feng Dong & Zhiwei XU, 2018. "Cycles of Credit Expansion and Misallocation: The Good, The Bad and The Ugly," 2018 Meeting Papers 444, Society for Economic Dynamics.

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    More about this item

    Keywords

    Net worth; borrowing constraints; heterogeneous projects; demand spillovers; credit multiplier; credit reversal; financial instability; endogenous credit cycles; nonlinear dynamics; intermittency; asymmetric fluctuations;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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