Kinks and Gains from Credit Cycles

Abstract

Credit-market imperfections are at the centre stage of several theories of business fluctuations. Since a lot of research seeks to address the welfare consequences of stabilization policies, we revisit the fundamental question of quantifying the cost of business cycles in a model where household borrowing is subject to a collateral constraint. Business cycles occasionally change the credit-market conditions, making households temporarily unconstrained and better off. This effect can dominate the conventional losses from uncertainty, thus making fluctuations welfare-dominate certainty.

Keywords: Collateral constraints, Cost of business cycles, precautionary saving

JEL Classification: E20, E32, E66