Discussion paper

DP1604 Endogenous Cycles in a Stiglitz-Weiss Economy

The literature on financial imperfections and business cycles has focused on propagation mechanisms. In this paper we model a pure reversion mechanism, such that the economy may converge to a two-period equilibrium cycle. This mechanism confirms that financial imperfections may have a dramatic amplification effect. Unlike some related models, contracts are complete. Indexation is not assumed away. The welfare properties of a possible stabilizing policy are analysed. The model itself is a dynamic extension of the well-known Stiglitz-Weiss model of lending under moral hazard. Although stylized, the model still captures some important features of credit cycles.

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Citation

Sussman, O and J Suarez (1997), ‘DP1604 Endogenous Cycles in a Stiglitz-Weiss Economy‘, CEPR Discussion Paper No. 1604. CEPR Press, Paris & London. https://cepr.org/publications/dp1604