TY  - JOUR
AU  - Lorenzoni,Guido
TI  - Inefficient Credit Booms
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13639
PY  - 2007
Y2  - November 2007
UR  - http://www.nber.org/papers/w13639
L1  - http://www.nber.org/papers/w13639.pdf
N1  - Author contact info:
Guido Lorenzoni
Department of Economics
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
Tel: 847/491-8243
Fax: 847/491-7001
E-Mail: guido.lorenzoni@northwestern.edu
AB  - This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though, from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis.
ER  -