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Adverse Selection and the Accelerator

  • Christopher L. House

    (University of Michigan)

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.

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Paper provided by EconWPA in its series Macroeconomics with number 0211015.

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Length: 38 pages
Date of creation: 22 Nov 2002
Date of revision:
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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