NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Agency Costs, Collateral, and Business Fluctuations

Ben S. Bernanke, Mark Gertler

NBER Working Paper No. 2015
Issued in August 1986
NBER Program(s):   EFG

Bad economic times are typically associated with a high incidence of financial distress, e.g., insolvency and bankruptcy. This paper studies the role of changes in borrower solvency in the initiation and propagation of the business cycle. We first develop a model of the process of financing real investment projects under asymmetric information, extending work by Robert Townsend. A major conclusion here is that when the entrepreneurs who borrow to finance projects are more solvent (have more "collateral"), the deadweight agency costs of investment finance are lower. This model of investment finance is then embedded in a dynamic macroeconomic setting. We show that, first, since reductions in collateral in bad times increase the agency costs of borrowing, which in turn depress the demand for investment, the presence of these financial factors will tend to amplify swings in real output. Second, we find that autonomous factors which affect the collateral of borrowers (as in a "debt-deflation") can actually initiate cycles in output.

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Document Object Identifier (DOI): 10.3386/w2015

Published:

  • Bernanke, Ben and Mark Gertler, "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, vol. 79, no. 1, pp. 14-31, March 1989
  • Ben Bernanke & Mark Gertler, 1986. "Agency costs, collateral, and business fluctuations," Proceedings, Federal Reserve Bank of San Francisco citation courtesy of

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