Cleansing by tight credit: rational cycles and endogenous lending standards

Farboodi, Maryam and Kondor, Peter ORCID: 0000-0001-9797-9291 (2023) Cleansing by tight credit: rational cycles and endogenous lending standards. Journal of Financial Economics, 150 (1). 46 - 67. ISSN 0304-405X

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Abstract

Endogenous cycles emerge through the two-way interaction between lending standards and production fundamentals. Lax lending standards in booms lead to low interest rates and high output but the deterioration of future loan quality. Low borrower quality in turn precipitates tight standards: the economy enters a recession with high credit spreads and low output but a gradual improvement in the quality of loans. This eventually triggers a shift back to a boom with lax lending, and the cycle continues. The capitalization of expert investors determines the strength of capital reallocation in recessions. Furthermore, although the constrained efficient economy is often cyclical, it features both a static and a dynamic externality in credit supply, hence differing from the decentralized equilibrium.

Item Type:	Article
Official URL:	https://www.sciencedirect.com/journal/journal-of-f...
Additional Information:	© 2023 Elsevier B.V.
Divisions:	Finance
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HG Finance
JEL classification:	E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information G - Financial Economics > G1 - General Financial Markets > G10 - General
Date Deposited:	22 May 2023 13:54
Last Modified:	04 Nov 2024 21:36
URI:	http://eprints.lse.ac.uk/id/eprint/119226

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