Financial Capacity And Output Fluctuations In An Economy With Multiperiod Financial Relationships
This paper motivates a financial propagation mechanism in the context of an intertemporal production economy with information, and with borrowers and lenders who enter multiperiod financial relationships. A key feature is that aggregate output and borrowers' "financial capacity"--the maximum overhang of past debt they may feasibly carry--are determined jointly. Expectations of future economic conditions govern financial capacity which in turn may constrain current production, especially in bad times. A small but persistent shift in aggregate conditions may have a large impact on financial capacity, making the framework capable of motivating large endogenous fluctuations in financial constraints. Copyright 1992 by The Review of Economic Studies Limited.
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