Credit and Business Cycles

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9320546 Kiyotaki One of the major features of the business cycle is the large, persistent, and correlated fluctuations of aggregate output, amount of credit and asset prices. This project will study theoretically how credit constraints interact with aggregate economic activity over the business cycle. In particular, for an economy where credit limits are endogenously determined the research will focus how relatively small, temporary shocks to technology or income generate large, persistent fluctuations in output and asset prices. Also, it is asked how shocks to a particular sector of the economy can transmit to the other sectors so that output and the amount of credit of different sectors move together. A dynamic general-equilibrium model of an economy is developed in which credit constraints arise naturally because lenders cannot force borrowers to repay debts unless debts are secured. The dynamic interaction between credit limits and asset prices is expected to be a powerful transmission mechanism by which the effects of shock persist, amplify, and spill over to the other sectors. This research is important because it will not only provide for a better understanding of the propagation mechanism of cycles through the credit system, but will also provide a useful framework for the empirical studies on business and residential investment and credit constraints. ***