MACROECONOMIC IMPLICATIONS OF FINANCIAL CONSTRAINTS 1. Credit crunch.
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MACROECONOMIC IMPLICATIONS OF FINANCIAL CONSTRAINTS
1. Credit crunch.
9th set of transparencies for ToCF
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INTRODUCTIONGREAT DEPRESSION
Irving Fisher (EMA 1933): aggrevated by "poor performance" of financial markets
DEBT DEFLATION
Bernanke (1983): breakdown in banking. Friedman-Schwartz (1963): role of money supply.
BALANCE SHEET CHANNEL vs
LENDING CHANNELTypical pattern:
Recession, high interest ratesweak balance sheets of firms
loan losses + low asset prices reduce equity in financial sector.
Two sectors (real + financial) are constrained.
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US 1990-91 recession (rather typical)
banks: reduction in capital ratio decline in bank lending
Same pattern in the wake of a tight money episode (Romer-Romer BPEA 1990).
Modeling : Apply logic of credit rationing to the two tiers.
flight to quality – credit crunch hits poor firms first– large/healthy firms can go to CP or bond markets.
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MODEL
Have 1 project / idea each
Moral hazard:
Risk neutral parties borrowers (firms) monitors (banks) investors
("firms")
return R
(success)
Investment costI
Verifiable 0
(failure)
(only good project is viable)
BORROWERS
good bad(low private
benefit)
Versions of the project
Bad (high private
benefit)
Private benefit:Prob( R)
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Have assets Cumulative distribution G(A).
("financial intermediaries", "banks")
can rule out high private benefit bad project of borrower at cost c (moral hazard).
uninformed / free riding (actually: implication of the model),
Exogenous interest rate:access to "storagefacility" yieldinginterest rate i.
Endogenous interest rate:savings.
demand expected return
MONITORS
INVESTORS
Total assets of intermediaries = Km.
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EXOGENOUS INTEREST RATE
Intermediation
Equilibrium
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Certification
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CertificationIntermediationVenture capitalist Lead investment bank Bankers acceptances(commercial paper)Partial securitization of a loan.
Bank loan(on balance sheet).
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Need
DIRECT FINANCE
where
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INDIRECT FINANCE
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Because firm wants to use as little informed capital as possible:
Firm gets financed if it has assets where
EQUILIBRIUM
is increasing in .
M:
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If interest rate is endogenous
Demand for uninformed capital:
Supply imperfectly elastic.
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COMPARATIVE STATICS3 types of recessions
Lending channel
Classical recession Balance
sheet channel
Correlation. Leads and lags
In the three types of capital squeeze, aggregate investment goes down and goes up.
Credit crunch Industrial recession Shortage of savings[Intermediaries] [Firms]
parameter of first order stochastic dominance
[Investors]
or
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[Empirical evidence.] Fact: small firms are prime victims of credit crunch.
CREDIT CRUNCH
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VARIABLE INVESTMENT SCALE
solvency ratio of banks (intermediation) increasesequity ratio of firms
A decrease in Km (credit crunch)
decreases increases decreases
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A decrease in Kb (balance sheet channel) decreases
decreases increases rm
decreases rb
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(1)
Description of equilibrium
(2)
(3)
inverse function of
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r increases with c
Intermediation (banks) vs certification (venture capital)
Banks have become low-intensity monitors over the years.
Certifiers have r = 1!
High monitoring intensity high solvency requirements.
Finance companies, firms themselves are higher- intensity monitors better capitalized.
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OTHER RESEARCH PROJECTS
Division of labor between intermediaries and firms, among intermediaries:
shallow vs deep information.
Simultaneous growth of financial and real sectors.Dynamics:
Increasing share of financial sector. Move toward less intensive monitoring.
Certification vs intermediation.