Working Paper: NBER ID: w20642
Authors: Jess Benhabib; Feng Dong; Pengfei Wang
Abstract: We introduce a simple adverse selection problem arising in credit markets into a standard textbook real business cycle model. There is a continuum of households and a continuum of anonymous producers who produce the final goods from intermediate goods. These producers do not have the resources to make up-front payments to purchase inputs and must do so by borrowing from competitive financial intermediates. However, lending to these producers is risky: honest borrowers will always pay off their debt, but dishonest borrowers will always default. This gives rise to an adverse selection problem for financial intermediaries. In a continuous-time real business cycle setting we show that such adverse selection generates multiple steady states and both local and global indeterminacy, and can give rise to equilibria with probabilistic jumps in credit, consumption, investment and employment driven by Markov sunspots under calibrated parameterizations and fully rational expectations. Introducing reputational effects eliminates defaults and results in a unique but still indeterminate steady state. Finally we generalize the model to firms with heterogeneous and stochastic productivity, and show that indeterminacies and sunspots persist.
Keywords: No keywords provided
JEL Codes: E32; E44; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| adverse selection in credit markets (D82) | multiple steady states (C62) |
| dishonest borrowers (G21) | lending externality (D62) |
| lending externality (D62) | local and global indeterminacy (D89) |
| honest borrowers (G21) | credit conditions (F34) |
| credit conditions (F34) | default risks (G33) |
| default risks (G33) | expansion in output (E23) |
| expansion in output (E23) | further credit supply (E51) |
| increase in lending (G21) | honest producers engaging in borrowing (G21) |
| honest producers engaging in borrowing (G21) | lower interest rates (E43) |
| lower interest rates (E43) | lower production costs (D24) |
| reputational effects (D91) | unique steady state (C62) |
| unique steady state (C62) | no defaults (Y70) |
| reputational effects (D91) | indeterminacy persists (D89) |