Rational Sentiments and Economic Cycles / Maryam Farboodi, Péter Kondor.

Format:

Book

Author/Creator:

Farboodi, Maryam.

Contributor:

National Bureau of Economic Research.

Kondor, Péter.

Series:

Working Paper Series (National Bureau of Economic Research) no. w27472.

NBER working paper series no. w27472

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2020.

Summary:

We propose a rational model of endogenous cycles generated by the two-way interaction between credit market sentiments and real outcomes. Sentiments are high when most lenders optimally choose lax lending standards. This leads to low interest rates and high output growth, but also to the deterioration of future credit application quality. When the quality is sufficiently low, lenders endogenously switch to tight standards, i.e. sentiments become low. This implies high credit spreads and low output, but a gradual improvement in the quality of applications, which eventually triggers a shift back to lax lending standards and the cycle continues. The equilibrium cycle might feature a long boom, a lengthy recovery, or a double-dip recession. It is generically different from the optimal cycle as atomistic lenders ignore their effect on the composition of the pool of borrowers. Carefully chosen macro-prudential or countercyclical monetary policy often improves the decentralized equilibrium cycle.

Notes:

Print version record

July 2020.