Endogenous credit standards and aggregate fluctuations |
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Affiliation: | 1. Research Department, Federal Reserve Bank of Philadelphia, USA;2. Research Department, Norges Bank, Oslo, Norway;3. Faculty of Economics and Business, University of Groningen, The Netherlands |
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Abstract: | Widespread empirical evidence shows that credit standards fluctuate over the business cycle. We build a macroeconomic model in which countercyclical lending standards emerge as an equilibrium outcome. In the model, banks compete on lending rates as well as collateral requirements. The presence of lending relationships between firms and banks gives rise to endogenous fluctuations in interest rate margins and collateral requirements. We demonstrate that endogenous credit standards amplify business cycles, driving up output volatility by around 25% when compared to a model without lending relationships. Finally, we show that in order to combat the effects of endogenous credit standards on macroeconomic volatility, a countercyclical loan-to-value ratio is an effective macroprudential policy tool. |
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Keywords: | Credit standards Collateral assets Deep habits Business cycle fluctuations DSGE modeling |
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