Lending standards, productivity, and credit crunches

Abstract We propose a macroeconomic model in which adverse selection investment amplifies fluctuations, line with the prominent role played by credit crunch during financial crisis. Endogenous lending standards emerge due to an informational asymmetry between borrowers and lenders about riskiness of borrowers. By using loan approval probability as screening device, banks ration following increases risk, generating large endogenous movements TFP, explaining why productivity often falls crises. Furthermore, mechanism implies that instability is heightened when interest rates are low.