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Good and Bad Investment: An Inquiry into the Causes of Credit Cycles


  • Kiminori Matsuyama


This paper develops models of endogenous credit cycles. The basic model has two types of profitable investment projects: the Good and the Bad. Unlike the Good, the Bad contributes little to improve the net worth of other borrowers. Furthermore, it is relatively difficult to finance externally due to the agency problem. In a recession, a low net worth prevents the agents from financing the Bad, and much of the saving goes to finance the Good. This leads an improvement in net worth. In a boom, a high net worth makes it possible for the agents to finance the Bad. At the peak of the boom, this shift in the composition of credit and of investment from the Good to the Bad causes a deterioration of net worth, and the economy plunges into a recession. The whole process repeats itself. Endogenous fluctuations occur because the Good breeds the Bad, and the Bad destroys the Good. When extended to incorporate the Bernanke-Gertler (1989) type credit multiplier mechanism, the model generates asymmetric fluctuations, along which the economy experiences a long and slow process of recovery from a recession, followed by a rapid expansion, and possibly after a period of high volatility, plunges into a recession.
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  • Kiminori Matsuyama, 2001. "Good and Bad Investment: An Inquiry into the Causes of Credit Cycles," Discussion Papers 1335, Northwestern University, Center for Mathematical Studies in Economics and Management Science, revised Sep 2001.
  • Handle: RePEc:nwu:cmsems:1335

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    References listed on IDEAS

    1. Matsuyama, Kiminori, 2001. "Growing through Cycles in an Infinitely Lived Agent Economy," Journal of Economic Theory, Elsevier, vol. 100(2), pages 220-234, October.
    2. Baumol, William J & Benhabib, Jess, 1989. "Chaos: Significance, Mechanism, and Economic Applications," Journal of Economic Perspectives, American Economic Association, vol. 3(1), pages 77-105, Winter.
    3. Azariadis, Costas & Smith, Bruce, 1998. "Financial Intermediation and Regime Switching in Business Cycles," American Economic Review, American Economic Association, vol. 88(3), pages 516-536, June.
    4. Philippe Aghion & Abhijit Banerjee & Thomas Piketty, 1999. "Dualism and Macroeconomic Volatility," The Quarterly Journal of Economics, Oxford University Press, vol. 114(4), pages 1359-1397.
    5. Kiminori Matsuyama, 2000. "Endogenous Inequality," Review of Economic Studies, Oxford University Press, vol. 67(4), pages 743-759.
    6. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    7. Boldrin, Michele & Woodford, Michael, 1990. "Equilibrium models displaying endogenous fluctuations and chaos : A survey," Journal of Monetary Economics, Elsevier, vol. 25(2), pages 189-222, March.
    8. Kiminori Matsuyama, 2000. "Financial Market Globalization and Endogenous Inequality of Nations," Discussion Papers 1300, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    9. Kiminori Matsuyama, 1999. "Growing Through Cycles," Econometrica, Econometric Society, vol. 67(2), pages 335-348, March.
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    Cited by:

    1. Hans Gersbach & Jan Wenzelburger, 2004. "Do Risk Premia Protect from Banking Crises," Levine's Bibliography 122247000000000356, UCLA Department of Economics.
    2. Kunieda, Takuma & Shibata, Akihisa, 2005. "Credit constraints and the current account: A test for the Japanese economy," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1261-1277, December.
    3. Kiminori Matsuyama, 2005. "Credit Market Imperfections and Patterns of International Trade and Capital Flows," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 714-723, 04/05.

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