Paper #916

Title:

Endogenous credit cycles

Author:

Alberto Martin

Date:

November 2004 (Revised: August 2008)

Abstract:

I develop an overlapping-generations framework in which changes in lending standards generate endogenous cycles. In my economy, entrepreneurs who are privately informed about the quality of their projects need to borrow funds. Intermediaries screen entrepreneurs both through the amount of investment undertaken and through the level of entrepreneurial net worth. I show that endogenous regime switches in financial contracts —from pooling to separating and vice-versa— may generate fluctuations even in the absence of exogenous shocks. When the economy is in the pooling (separating) regime, lending standards seem “lax” (“tight”) and investment is high (low). Differently from the existing literature, my model does not require entrepreneurial net worth to be counter cyclycal or inconsequential for determining aggregate investment.

Keywords:

Endogenous cycles, financial accelerator, adverse selection, pooling equilibrium, separating equilibrium

JEL codes:

D82, E32, E44

Area of Research:

Macroeconomics and International Economics

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