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A Model of Moral-Hazard Credit Cycles

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  • Roger B. Myerson

Abstract

This paper considers a simple model of credit cycles driven by moral hazard in financial intermediation. Financial agents or bankers must earn moral-hazard rents, but the cost of these rents can be efficiently spread over an agent's entire career by promising large late-career rewards if the agent has a consistently successful record. Dynamic interactions among different generations of financial agents can create credit cycles with repeated booms and recessions. In recessions, a scarcity of trusted financial intermediaries limits investment and reduces employment. Under such conditions, taxing workers to subsidize bankers may increase employment enough to make the workers better off.

Suggested Citation

  • Roger B. Myerson, 2012. "A Model of Moral-Hazard Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 120(5), pages 847-878.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/668839
    DOI: 10.1086/668839
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    References listed on IDEAS

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    1. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    2. Giovanni Favara, 2012. "Agency Problems and Endogenous Investment Fluctuations," The Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2301-2342.
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