Moore that shows how small shocks to the economy might be amplified by credit restrictions, giving rise to large output fluctuations. The model assumes that borrowers cannot be forced to repay their debts. Therefore, in equilibrium, lending occurs only if it is collateralized. That is, borrowers must own a sufficient quantity of capital that can be confiscated in case they fail to repay.

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March 21, in economics Tags: economics , financial crisis , incentives Grading still hangs over me but teaching is done. So, I finally had time to read Kiyotaki Moore.

So, some papers in my queue were cleared out and Kiyotaki-Moore leaped over several others. I see why the paper has over cites on Google Scholar. The main propagation mechanism in the model relies on the idea that credit-constrained borrowers borrow against collateral. Suppose there is an unexpected positive shock to the productivity of land. This increases the value of land and hence its price.

This capital gain increases borrowing. An increase in the value of land increases economic activity. It also increases demand for land and hence the price of land. This can choke off some demand for land. The more elastic the supply of land, the smaller is the latter dampening effect. So there can be a significant multiplier to a positive shock to technology. Why are borrowers constrained in their borrowing by the value of their land and rather than the NPV of their projects?

Kiyotaki-Moore rely on a model of debt of Hart and Moore to justify this constraint. While Hart-Moore is also in my pile, I did not finally have time to read it. I did note they have an extremely long Appendix to justify the connection between collateral and borrowing!

The main idea in Hart Moore is that an entrepreneur can always walk away from a project and hold it up. The Appendix must argue that he captures all the surplus above the liquidation value of the land. Hence, the lender will only be willing to lend up to value of collateral to avoid hold up. But how do we get credit cycles?

As the price of land rises, the entrepreneurs acquire more land. This increases the price of land. They also accumulate debt. The debt constrains their ability to borrow and eventually demand for land declines and its price falls. A cycle. Notice that this cycle is not generated by shocks to technology or preferences but arises endogenously as land and debt holdings vary over time! I gotta think about this part moreā€¦.


Nobuhiro Kiyotaki



Credit Cycles


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