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Adverse Selection and the Accelerator

Author

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  • Christopher L. House

    (University of Michigan)

Abstract

This paper reexamines the relationship between financial market imperfections and economic instability. I present a model in which financial accelerator effects come from adverse selection in credit markets. Unlike other models of the financial accelerator, the model I present has the potential to stabilize the economy rather than destabilize it. The stabilizing forces in the dynamic model are closely related to forces that cause overinvestment in static models. Consequently, the stabilizing properties of the model are not specific to adverse selection but rather are present in any environment in which credit market distortions cause overinvestment. When investment projects are equity financed, or when contracts are written optimally, the only equilibria that emerge are stabilizer equilibria. Thus, stabilizing outcomes are more robust in this model. Finally, the empirical distinction between accelerator equilibria and stabilizer equilibria is subtle. Many statistics used to test for financial accelerators are observationally equivalent in stabilizer equilibria.

Suggested Citation

  • Christopher L. House, 2002. "Adverse Selection and the Accelerator," Macroeconomics 0211015, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0211015 Note: Type of Document - Acrobat PDF; prepared on IBM PC ; to print on HP; pages: 38 ; figures: included
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    References listed on IDEAS

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    Cited by:

    1. Giovanno Favara, 2006. "Agency Costs, Net Worth, and Endogenous Business Fluctuations," 2006 Meeting Papers 400, Society for Economic Dynamics.
    2. Bean, Charles & Larsen, Jens D. J. & Nikolov, Kalin, 2002. "Financial frictions and the monetary transmission mechanism: theory, evidence and policy implications," Working Paper Series 0113, European Central Bank.
    3. Ronel Elul, 2005. "Collateral, credit history, and the financial decelerator," Working Papers 05-23, Federal Reserve Bank of Philadelphia, revised 01 Mar 2007.
    4. House, Christopher L., 2006. "Adverse selection and the financial accelerator," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1117-1134, September.

    More about this item

    Keywords

    subliminal extant Smith economagic gmm;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • 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
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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