Working Paper: NBER ID: w16031
Authors: Lucian A. Bebchuk; Itay Goldstein
Abstract: This paper develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, with their success depending on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of alternative measures for getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, infusion of capital into banks, direct lending to operating firms by the government, and the provision of government capital or guarantees to finance or encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the financial crisis of 2008-2009.
Keywords: credit market freeze; government intervention; financial crisis; interest rates; capital infusion; direct lending
JEL Codes: D21; E44; E58; E62; G18; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks' expectations (G21) | lending behavior (G21) |
| interest rate cuts (E43) | likelihood of credit freeze (G21) |
| capital infusion (O16) | probability of credit freeze (E51) |
| direct government lending to operating firms (H81) | likelihood of credit freeze (G21) |
| government guarantees (H81) | lending behavior (G21) |