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Interest Rate Dynamics, Variable-Rate Loan Contracts, and the Business Cycle

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  • Patrick A. Pintus
  • Yi Wen
  • Xiaochuan Xing

Abstract

The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates forecast booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when business-cycle movements are driven, in a significant way, by animal spirit shocks to credit-financed investment demand. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the loan has a variable-rate component. In addition, Bayesian estimation of our benchmark DSGE model on US data 1975-2010 shows that movements in investment driven by animal spirits are quantitatively important and result in a better fit to the data than both standard RBC models and Kiyotaki-Moore type models with unique equilibrium.

Suggested Citation

  • Patrick A. Pintus & Yi Wen & Xiaochuan Xing, 2015. "Interest Rate Dynamics, Variable-Rate Loan Contracts, and the Business Cycle," Working Papers 2015-32, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2015-032
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    References listed on IDEAS

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    2. Margarita Rubio & José A. Carrasco-gallego, 2017. "Bank Capital Requirements and Collateralised Lending Markets," Manchester School, University of Manchester, vol. 85, pages 79-103, September.

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    More about this item

    Keywords

    Endogenous Borrowing Constraints; Collateral; Variable-Rate Loans; Multiple Equilibria; sunspot shocks;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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