Adverse selection and the financial accelerator House, Christopher L

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House, Christopher L
Appears In
Journal of Monetary Economics
Financial markets -- Analysis; Economics; Investments -- Analysis
Academic; Trade
To link to full-text access for this article, visit this link: Byline: Christopher L. House Abstract: Many economists believe that credit market distortions create a financial accelerator which destabilizes the economy. This paper shows that when credit market distortions arise from adverse selection they sometimes stabilize the economy rather than destabilize it. The stabilizing forces are closely related to forces that cause overinvestment in static models. When investment projects are equity financed, or when contracts are written optimally, the distortions always stabilize the economy. Thus, stabilizing equilibria are a robust feature of the model. The empirical distinction between accelerator and stabilizer equilibria is subtle. Many empirical tests are unable to distinguish between accelerator and stabilizer equilibria. Author Affiliation: Department of Economics, University of Michigan, 238 Lorch Hall, Ann Arbor, MI 48109-1220, USA Article History: Received 7 December 2004; Revised 9 February 2005; Accepted 21 February 2005 Article Note: (footnote) [star] I thank John Leahy for important input into this paper. Robert Barsky, Russell Cooper, Simon Gilchrist, Robert King, Jeff Miron, and Matthew Shapiro provided valuable comments, insights and suggestions.
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