Credit Search and Credit Cycles

Abstract

The supply and demand of credit are not always well aligned and matched, as is reflected in the countercyclical excess reserve-to-deposit ratio and interest spread between the lending rate and the deposit rate. We develop a search-based theory of credit allocations to explain the cyclical fluctuations in both bank reserves and the interest spread. We show that search frictions in the credit market can not only naturally explain the countercyclical bank reserves and interest spread, but also generate endogenous business cycles driven primarily by the cyclical utilization rate of credit resources, as long conjectured by the Austrian school of the business cycle. In particular, we show that credit search can lead to endogenous local increasing returns to scale and variable capital utilization in a model with constant returns to scale production technology and matching functions, thus providing a micro-foundation for the indeterminacy literature of Benhabib and Farmer (1994) and Wen (1998).

Introduction to the symposium on bubbles, multiple equilibria, and economic activities

“…One can add many others to this list such as imperfect contract enforcement, search and matching, credit constraints, and agency conflict. Dong et al (2015) provide a search-based model to formalize the Austrian idea of business cycles, which emphasizes bank issuance of credit as the main cause of economic fluctuations. Their model features three types of agents: a representative household with a continuum of ex ante identical members (depositors), a representative bank with a continuum of ex ante identical loan officers, and a continuum of firms.…”