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Overborrowing and Systemic Externalities in the Business Cycle

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  • Javier Bianchi

Abstract

Credit constraints that link a private agent's debt to market-determined prices embody a credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to ``overborrow." The externality arises because agents fail to internalize the price effects of additional borrowing when the credit constraint binds. We quantify the effects of this inefficiency in a two-sector DSGE model of a small open economy calibrated to emerging markets. The credit externality increases the probability of financial crises by a factor of 7 and causes the maximum drop in consumption to increase by 10 percentage points.

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  • Javier Bianchi, 2010. "Overborrowing and Systemic Externalities in the Business Cycle," 2010 Meeting Papers 96, Society for Economic Dynamics.
    • Handle: RePEc:red:sed010:96
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    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • F20 - International Economics - - International Factor Movements and International Business - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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