Leveraged Financing, Over Investment, and Boom-Bust Cycles

FRB of St. Louis Working Paper No. 2008-014C

31 Pages Posted: 5 Jun 2008 Last revised: 3 Dec 2009

See all articles by Patrick Pintus

Patrick Pintus

Aix-Marseille University and CNRS

Yi Wen

Federal Reserve Bank of St. Louis - Research Department; Tsinghua University

Date Written: June 25, 2009

Abstract

It has long been argued in the history of economic thought that over investment through highly leveraged borrowing under elastic credit supply may generate large boom-bust business cycles. This paper rationalizes this idea in a dynamic general equilibrium model with infinitely lived rational agents. It shows that dynamic interactions between strong asset-accumulation motives (based on habit formation on the borrower side) and elastic credit supply (based on collateralized lending on the lender side) generate a multiplier-accelerator mechanism that can transform a one-time technological innovation into large and long-lasting boom-bust cycles. Such cycles share many features in common to investment bubbles observed in the history (such as the IT bubble in the 1990s and the 2000s housing bubble.).

Keywords: Excess Demand, Over-Investment, Borrowing Constraints, Multiplier-Accelerator, Elastic Credit Supply

JEL Classification: E21, E22, E32, E44, E63

Suggested Citation

Pintus, Patrick and Wen, Yi, Leveraged Financing, Over Investment, and Boom-Bust Cycles (June 25, 2009). FRB of St. Louis Working Paper No. 2008-014C, Available at SSRN: https://ssrn.com/abstract=1140708 or http://dx.doi.org/10.2139/ssrn.1140708

Patrick Pintus

Aix-Marseille University and CNRS ( email )

Ilot Bernard Dubois
5-9 Boulevard Maurice Bourdet
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France
0609397281 (Phone)

HOME PAGE: http://https://sites.google.com/site/patrickpintus/

Yi Wen (Contact Author)

Federal Reserve Bank of St. Louis - Research Department ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8559 (Phone)
314-444-8731 (Fax)

Tsinghua University ( email )

Beijing, 100084
China

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