Inefficient Credit Booms

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ID: 307197
2008
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Ranked #31 of 212 articles by views in The Review of Economic Studies

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Abstract
This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies, which can be used during a credit boom to reduce the expected costs of a financial crisis.
Reference Key
openalex_W3123218961 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Guido Lorenzoni
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Journal The Review of Economic Studies
Year 2008
DOI
10.1111/j.1467-937x.2008.00494.x
URL
https://doi.org/10.1111/j.1467-937x.2008.00494.x
Keywords Keywords not found

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