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Adverse Selection and Self-fulfilling Business Cycles

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  • Pengfei Wang

    (Hong Kong University of Science and Tech)

  • Feng Dong

    (Shanghai Jiao Tong University)

  • Jess Benhabib

    (NYU)

Abstract

We develop a macroeconomic model with adverse selection in credit markets. A continuum of final-goods producers borrow from financial intermediary to purchase intermediate goods as input. The type of producers as borrower is private information. Adverse selection arises here. Higher aggregate supply of credit induces more high-quality borrowers, lowers default risks face by each financial intermediary, and stimulate more individual credit supply. We show that this lending externality can generate multiple equilibria or indeterminacy even when the steady state equilibrium is unique, making self-fulfilling expectation driven business cycles possible.

Suggested Citation

  • Pengfei Wang & Feng Dong & Jess Benhabib, 2016. "Adverse Selection and Self-fulfilling Business Cycles," 2016 Meeting Papers 1526, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1526
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    3. Gilbert Mbaraa & Ryszard Kokoszczyński, 2018. "Corporate governance, tax evasion and business cycles," Working Papers 2018-10, Faculty of Economic Sciences, University of Warsaw.
    4. Feng Dong & Pengfei Wang & Yi Wen, 2016. "Credit search and credit cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(2), pages 215-239, February.
    5. Abad, Nicolas & Lloyd-Braga, Teresa & Modesto, Leonor, 2020. "The failure of stabilization policy: Balanced-budget fiscal rules in the presence of incompressible public expenditures," Journal of Economic Dynamics and Control, Elsevier, vol. 120(C).
    6. Zhifeng Cai & Feng Dong, 2021. "A Model of Secular Migration from Centralized to Decentralized Trade," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 201-244, July.
    7. Gokmen, Gunes & Morin, Annaig, 2021. "Investment shocks and inequality dynamics," Economic Modelling, Elsevier, vol. 94(C), pages 570-579.
    8. Kevin x.d. Huang & Qinglai Meng & Jianpo Xue, 2019. "Capital Income Taxation and Aggregate Instability," Vanderbilt University Department of Economics Working Papers 19-00007, Vanderbilt University Department of Economics.
    9. Bruce McGough & Ryuichi Nakagawa, 2019. "Stability of Sunspot Equilibria under Adaptive Learning with Imperfect Information," Working Papers on Central Bank Communication 005, University of Tokyo, Graduate School of Economics.
    10. Cui, Wei & Kaas, Leo, 2021. "Default cycles," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 377-394.
    11. Jonathan Swarbrick, 2019. "Lending Standards, Productivity and Credit Crunches," Staff Working Papers 19-25, Bank of Canada.
    12. Fernando M. Duarte & Anna Zabai, 2015. "An interest rate rule to uniquely implement the optimal equilibrium in a liquidity trap," Staff Reports 745, Federal Reserve Bank of New York.

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    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
    • G01 - Financial Economics - - General - - - Financial Crises

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