Abstract
We characterize the equilibrium set of a two-good, pure-credit economy with limited commitment, under both pairwise and centralized meetings. We show that the set of equilibria derived under “not-too-tight” solvency constraints (Alvarez and Jermann, 2000) commonly used in the literature is of measure zero in the whole set of Perfect Bayesian Equilibria. There exist a continuum of stationary equilibria, a continuum of endogenous credit cycles of any periodicity, and a continuum of sunspot equilibria, irrespective of the assumed trading mechanism. Equilibria featuring “too-tight” solvency constraints can generate growing credit limits over time, periodic credit shutdowns, and heterogeneous debt limits across ex-ante identical borrowers. Moreover, we provide examples of credit cycles that dominate, from a social welfare point of view, all equilibria with “not-too-tight” solvency constraints.
Original language | English |
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Pages (from-to) | 556-584 |
Number of pages | 29 |
Journal | Journal of Economic Theory |
Volume | 175 |
Early online date | 14 Feb 2018 |
DOIs | |
Publication status | Published - May 2018 |
Research Groups and Themes
- ECON Microeconomic Theory
- ECON Macroeconomics
Keywords
- Credit cycles
- Limited commitment
- Money