Financial constraints and unemployment equilibrium

The aim of this paper is to show that a robust determination of unemployment equilibria can be based on the integration of credit rationing into a general equilibrium model. We first review some of the Keynesian macroeconomic models. We show that the problems bequeathed by Keynes’ legacy are only partially solved by the strand of the new Keynesian economics based on market imperfections and endogenous rigidities. In order to overcome these problems we refer to credit rationing. In particular, we build a simple general equilibrium model in which prices are–in principle–perfectly flexible and credit rationing implies unemployment equilibria.     

Credit rationing or overlending? An exploration into financing imperfection

Small and new firms are deemed to be unable to obtain sufficient bank loans. This idea finds a strong theoretical support in credit rationing theory. However, this is vigorously challenged by De Meza and Webb (1987, 2000) suggesting that firms can benefit from an excess of credit, i.e. overlending. Credit rationing or overlending? The contribution of this empirical article is twofold: to our knowledge, it is the first to make an attempt in measuring the relative importance of these two types of financing imperfection and to explore factors leading to one or the other. We exploit a rich panel data set on the access to bank credit for new French businesses during the mid-1990s. Our results show that credit rationing was not highly spread among French new firms. The story told by De Meza and Webb (1987) appears to be a much more realistic model. In addition, we identify factors, linked to the starter, the project or the industry, that are closely associated with credit rationing and/or overlending. Most factors enter into a consistent relation: when they are positively (negatively) associated with credit rationing, they are negatively (positively) associated with overlending.     

Feedback effects between credit ratings and financial markets

Credit rating agencies often make sharp adjustments in their pronouncements during times of stress in financial markets. These adjustments typically happen with a delay relative to shocks in market prices. Since prices convey information about what market participants are doing and thinking, it is likely that rating agencies take into account market prices when issuing their pronouncements.In order to understand the relationship between credit ratings and financial prices, we develop a model of debt roll-over in which rating agencies incorporate information publicly available in financial markets. We find that (1) rating agencies respond to market prices, i.e. nonfundamental price volatility can shift financing conditions from a low risk spread and high credit rating equilibrium to an equilibrium with high spread and low rating, and (2) rating agencies can anchor expectations about the equilibrium in financial markets, thus serving as an antidote to nonfundamental price volatility.     

Hedging and temporal permit issuances in cap-and-trade programs: The Market Stability Reserve under risk aversion

Cap-and-trade programs such as the European Union's Emissions Trading System (EU ETS) expose firms to considerable risks, to which the firms can respond with hedging. We develop an intertemporal stochastic equilibrium model to analyze the implications of hedging by risk-averse firms. We show that the resulting time-varying risk premium depends on the size of the permit bank. Applying the model to the EU ETS, we find that hedging can lead to a U-shaped price path, because prices initially fall due to negative risk premiums and then rise as the hedging demand declines. The Market Stability Reserve (MSR) reduces the permit bank and thus, increases the hedging value of the permits. This offers an explanation for the recent price hike, but also implies that prices may decline in the future due to more negative risk premiums. In addition, we find higher permit cancellations through the MSR than previous analyses, which do not account for hedging.     

The influence of black markets on a queue-rationed centrally planned economy

In centrally planned economies in which prices are fixed, and the rationing mechanism is waiting line queues, we show that an equilibrium of waiting times exists. We then introduce a “black market” in which individuals can trade commodities that they have acquired through the official economy. An equilibrium of black market prices and waiting times is shown to exist; further, the economy with a black market is “queue-efficient.”. However, the introduction of black markets is not necessarily a Pareto improvement over an economy without black markets (even when we allow winners to compensate losers).     

Interfirm Bundling and Vertical Product Differentiation

In this paper, we study the competitive effects of bundled discounts offered by pairs of independent firms. In a setting with vertically differentiated goods, where firms decide whether to participate in a discounting scheme before prices are set, it is shown that, in equilibrium, all pairs of firms producing goods of the same quality level offer bundled discounts. Relative to the no‐bundling benchmark, we find that (i) all headline prices rise, (ii) all bundle prices, net of the respective discount, decrease, and (iii) only high‐quality sellers will obtain higher profits. Furthermore, this equilibrium corresponds to the worst scenario in terms of consumer welfare, and it and decreases social welfare.     

Coalition-proof supply function equilibria in oligopoly

In an industry where firms compete via supply functions, the set of equilibrium outcomes is large. If decreasing supply functions are ruled out, this set is reduced significantly, but remains large. Specifically, the set of prices that can be sustained by supply function equilibria is the interval between the competitive price and the Cournot price. In sharp contrast, when the number of firms is above a threshold we identify (e.g., three if demand is linear), only the Cournot outcome can be sustained by a coalition-proof supply function equilibrium.     

Investment dynamics in electricity markets

We investigate the incentives for investments in capacity in a simple strategic dynamic model with random demand growth. We construct non-collusive Markovian equilibria where the firms?? decisions depend on the current capacity stock only. The firms maintain small reserve margins and high market prices, and extract large rents. In some equilibria, rationing occurs with positive probability, so the market mechanism does not ensure ??security of supply??. Usually, the price cap reflects the value of lost energy or lost load (VOLL) that consumers place on severely reducing consumption on short notice. Our analysis identifies a minimum price cap, unrelated to the VOLL, that allows the firms to recoup their investment and production costs in equilibrium. However, raising the price cap above this minimum increases market prices and reduces consumer surplus, without affecting the level of investment.     

The Effects of Screening and Monitoring on Credit Rationing of SMEs

In this paper, we seek to empirically assess which determinants of the capability and incentives of banks to screen and monitor firms are significant in explaining credit rationing to Italian SMEs. After testing for the presence of non‐random selection bias and the potential endogeneity of some determinants of interest, the probit model results we obtain suggest that the average banking size and the multiple banking relationship phenomenon are statistically significant factors affecting credit rationing, presumably through their impact on the aforementioned banks' capability and incentives. Other potential determinants of banks' incentives to monitor and screen, such as local banking competition and firm' capacity to collateralize, are never significant. However, when we split the sample according to the level of competition in credit markets, we find that the estimated marginal effects of all significant determinants of interest are larger in absolute value than those obtained when using the whole sample.     

On the disequilibrium dynamics of sequential monetary economies

The purpose of this paper is to study the dynamic behavior of a sequential monetary exchange economy. Transactions take place sequentially against non-equilibrium prices, there is quantity rationing, and credit or cash are the only means of exchange. Agents have optimistic or pessimistic expectations about quantity constraints that represent their beliefs about future trading opportunities.In the credit model the agents incur debts along the transition path towards equilibrium, while in the cash-in-advance model convergence takes place without the occurrence of any debts or claims. The credit mechanism is shown to act as a ‘soft’ correction mechanism on credit fluctuations, while the cash-in-advance constraint acts as a ‘hard’ negative feedback effect driving the prices back towards a neighborhood of a monetary cash-in-advance equilibrium.     

Labour unions and multi‐product firms in closed and open economies

Abstract This paper sets up a general oligopolistic equilibrium model with multi‐product firms and union wage setting. In this model, we conduct two policy experiments. First, we show that deunionization induces a general decline in firm scale and scope, the respective reduction being more pronounced in non‐unionized industries. Second, we study the consequences of trade liberalization, and show that access to foreign markets lowers firm scope in all industries as well as the scope differential between unionized and non‐unionized firms. Adjustments in firm scale turn out to be less clear‐cut and, inter alia, depend on the degree of product differentiation.     

Restoring Macroeconomic Stability through Fiscal Adjustment: a Real–Financial CGE Analysis for India

Developing‐country attempts to regain macroeconomic stability through fiscal adjustment are often unsuccessful in reducing inflation and balance‐of‐payments (BoP) disequilibrium. This paper examines why this may be so in the light of India's experience with stabilization in response to the BoP crisis in 1991. It does so using a novel real–financial computable general‐equilibrium model. Focusing on credit rather than money, the model goes beyond earlier modeling approaches by (1) incorporating credit rationing, (2) recognizing the dual role of credit for working capital and investment, and (3) allowing for switches between credit‐constrained, capacity‐constrained, and demand‐constrained, regimes. The simulations indicate that the macroeconomic effects of monetized deficit reduction differ widely depending on the mode of financing and on initial conditions in real and financial markets. Whenever fiscal reform leads to a squeeze on available working capital credit, deficit reduction will lead to only a limited inflation decline and a modest BoP improvement.     

Industry dynamics: Foundations for models with an infinite number of firms

This paper explores the connection between three important threads of economic research offering different approaches to studying the dynamics of an industry with heterogeneous firms. Finite models of the form pioneered by Ericson and Pakes (1995) capture the dynamics of a finite number of heterogeneous firms as they compete in an industry, and are typically analyzed using the concept of Markov perfect equilibrium (MPE). Infinite models of the form pioneered by Hopenhayn (1992), on the other hand, consider an infinite number of infinitesimal firms, and are typically analyzed using the concept of stationary equilibrium (SE). A third approach uses oblivious equilibrium (OE), which maintains the simplifying benefits of an infinite model but within the more realistic setting of a finite model. The paper relates these three approaches. The main result of the paper provides conditions under which SE of infinite models approximate MPE of finite models arbitrarily well in asymptotically large markets. Our conditions require that the distribution of firm states in SE obeys a certain “light-tail” condition. In a second set of results, we show that the set of OE of a finite model approaches the set of SE of the infinite model in large markets under a similar light-tail condition.     

Credit risk in general equilibrium

This paper contributes to the literature on default in general equilibrium. Borrowing and lending takes place via a clearing house (bank) that monitors agents and enforces contracts. Our model develops a concept of bankruptcy equilibrium that is a direct generalization of the standard general equilibrium model with financial markets. Borrowers may default in equilibrium and returns on loans are determined endogenously. Restricted to a special form of mean variance preferences, we derive a version of the capital asset pricing model with bankruptcy. In this case, we can characterize equilibrium prices and allocations and discuss implications for credit risk modeling.     

Countervailing Power and Price Transparency*

We investigate whether improved transparency about prices may increase the countervailing power exercised by buyers of an intermediate good. In a model with an informed manufacturer that sells to both informed and uninformed firms, we show that full transparency cannot be part of equilibrium due to the strategic effect of the resulting informational spillover. Transparency policies introduce a distortion for informed segments and are unsuccessful in completely removing the distortion from the uninformed segment. Welfare effects are hence ambiguous and depend on the weight assigned to uninformed markets. Our results thus cast further doubt on the value of transparency.     

Long-run industry equilibrium with uncertainty

In this paper we consider the effects of uncertainty on industry equilibrium when firms must commit themselves to production before prices are revealed. We show that (a) an increase in demand uncertainty will (i) not affect the equilibrium number and size of firms if they are risk neutral, (ii) reduce the equilibrium number of firms if they are risk averse, but will have an ambiguous effect on their size. (b) In equilibrium, firms operate at capacity if they are risk neutral, but at excess capacity if they are risk averse.     

The underground economy and its macroeconomic consequences

This study develops a dynamic general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.     

Price competition,free entry,and welfare in congested markets

In this paper we study the problem of price competition and free entry in congested markets. In particular, we consider a network with multiple origins and a common destination node, where each link is owned by a firm that sets prices in order to maximize profits, whereas users want to minimize the total cost they face, which is given by the congestion cost plus the prices set by firms. In this environment, we introduce the notion of Markovian Traffic Equilibrium to establish the existence and uniqueness of a pure strategy price equilibrium, without assuming that the demand functions are concave nor imposing particular functional forms for the latency functions. We derive explicit conditions to guarantee existence and uniqueness of equilibria. Given this existence and uniqueness result, we apply our framework to study entry decisions and welfare, and establish that in congested markets with free entry, the number of firms exceeds the social optimum.     

Lending technologies,banking relationships,and firms’ access to credit in Italy: the role of firm size

This paper analyses the role of lending technologies and banking relationships on firms’ credit access in Italy. Using EFIGE firm-level data, we show that the depth and strength of firm–bank relationships have heterogeneous effects on credit demand and rationing probabilities depending on the size of the borrower. Multiple banking relationships alleviate financial constraints for small firms, while borrowing from a large number of lenders hinders access to credit for large companies. Small and medium-sized enterprises with a higher share of debt with the main bank have a lower probability of being credit denied, as debt concentration contributes to overcome the opacity problems typical of the SMEs. Long-lasting relationships, by reducing information asymmetries, significantly improve access to credit for small and large firms. Conversely, we find that medium-sized enterprises are more exposed to financing constraints as relationship duration increases, due to possible lock-in effects. Finally, firms maintaining banking relationships based on transactional technologies are more likely to be credit denied, while the use of relationship lending technologies improves credit availability for both small and large enterprises.