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Endogenous Credit Cycles

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Abstract

We build a model in which verifiability of private debts, timing mismatch in debt settlements and borrowing leverage lead to liquidity crisis in the financial market. Central bank can respond to the liquidity crisis by adopting an unconventional monetary policy that resembles repurchase agreements between the central bank and the lenders. This policy is effective if the timing mismatch is nominal (i.e., a settlement participation risk). It is ineffective if the timing mismatch is driven by a real shock (i.e., preference shock).

Suggested Citation

  • Chao Gu & Joseph Haslag, 2011. "Endogenous Credit Cycles," Working Papers 1114, Department of Economics, University of Missouri.
    • Handle: RePEc:umc:wpaper:1114
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    References listed on IDEAS

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    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    2. Schreft, Stacey L & Smith, Bruce D, 2002. "The Conduct of Monetary Policy with a Shrinking Stock of Government Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 848-882, August.
    3. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-864, November.
    4. John Moore & Nobuhiro Kiyotaki, 2008. "Liquidity, Business Cycles, and Monetary Policy," 2008 Meeting Papers 35, Society for Economic Dynamics.
    5. Viral V. Acharya & S. Viswanathan, 2011. "Leverage, Moral Hazard, and Liquidity," Journal of Finance, American Finance Association, vol. 66(1), pages 99-138, February.
    6. Robert E. Hall, 2011. "The High Sensitivity of Economic Activity to Financial Frictions," Economic Journal, Royal Economic Society, vol. 121(552), pages 351-378, May.
    7. Orphanides, Athanasios, 2002. "Comment on the Conduct of Monetary Policy with a Shrinking Stock of Government Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 883-886, August.
    8. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
    9. Stephen D. Williamson, 2012. "Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach," American Economic Review, American Economic Association, vol. 102(6), pages 2570-2605, October.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    liquidity problem; timing mismatch; leveraging; liquidity shock; settlement risk; repurchase agreement; consumption shock;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises

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