Credit and Business Cycles

This paper presents two dynamic models of the economy in which credit constraints arise because creditors cannot force debtors to repay debts unless the debts are secured by collateral. The credit system becomes a powerful propagation mechanism by which the effects of shocks persist and amplify through the interaction between collateral values, borrowers' net worth and credit limits. In particular, when ®xed assets serve as collateral, I show that relatively small, temporary shocks to technology or wealth distribution can generate large, persistent ̄uctuations in output and asset prices. JEL Classi®cation Numbers: E32, E44.