This paper is a theoretical study into how credit constraints interact with aggregate economic activity over the business cycle. We construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets such as land, buildings and machinery play a dual role: they are not only factors of production, but they also serve as collateral for loans. Borrowers' credit limits are affected by the prices of the collateralized assets. And at the same time, these prices are affected by the size of the credit limits. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors.
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Moore that shows how small shocks to the economy might be amplified by credit restrictions, giving rise to large output fluctuations. The model assumes that borrowers cannot be forced to repay their debts. Therefore, in equilibrium, lending occurs only if it is collateralized. That is, borrowers must own a sufficient quantity of capital that can be confiscated in case they fail to repay.
This collateral requirement amplifies business cycle fluctuations because in a recession , the income from capital falls, causing the price of capital to fall, which makes capital less valuable as collateral, which limits firms' investment by forcing them to reduce their borrowing, and thereby worsens the recession. Kiyotaki a macroeconomist and Moore a contract theorist originally described their model in a paper in the Journal of Political Economy.
The Kiyotaki—Moore model shows instead how relatively small shocks might suffice to explain business cycle fluctuations, if credit markets are imperfect. In their model economy, Kiyotaki and Moore assume two types of decision makers , with different time preference rates: "patient" and "impatient. The "impatient" agents are called "farmers" in the original paper, but should be interpreted as entrepreneurs or firms that wish to borrow in order to finance their investment projects.
Two key assumptions limit the effectiveness of the credit market in the model. First, the knowledge of the "farmers" is an essential input to their own investment projects—that is, a project becomes worthless if the farmer who made the investment chooses to abandon it.
Second, farmers cannot be forced to work, and therefore they cannot sell off their future labor to guarantee their debts. Together, these assumptions imply that even though farmers' investment projects are potentially very valuable, lenders have no way to confiscate this value if farmers choose not to pay back their debts.
Therefore, loans will only be made if they are backed by some other form of capital which can be confiscated in case of default. In other words, loans must be backed by collateral. Kiyotaki and Moore's paper considers land as an example of a collateralizable asset. Thus land plays two distinct roles in the model: i it is a productive input, and ii it also serves as collateral for debt.
Hence, impatient agents must provide real estate as collateral if they wish to borrow. If for any reason the value of real estate declines, so does the amount of debt they can acquire.
This feeds back into the real estate market, driving the price of land down further thus, the borrowing decisions of the impatient agents are strategic complements. This positive feedback is what amplifies economic fluctuations in the model. The paper also analyzes cases where debt contracts are set only in nominal terms or where contracts can be set in real terms, and considers the differences between the cases.
The original paper of Kiyotaki and Moore was theoretical in nature, and made little attempt to evaluate the quantitative relevance of their mechanism for actual economies. In , Kiyotaki's student Matteo Iacoviello embedded the Kiyotaki-Moore mechanism inside a standard New Keynesian general equilibrium macroeconomic model. From Wikipedia, the free encyclopedia. Structure of the model [ edit ] In their model economy, Kiyotaki and Moore assume two types of decision makers , with different time preference rates: "patient" and "impatient.
Extensions [ edit ] The original paper of Kiyotaki and Moore was theoretical in nature, and made little attempt to evaluate the quantitative relevance of their mechanism for actual economies. Journal of Political Economy. American Economic Review. Categories : New Keynesian economics Economics models Business cycle theories. Namespaces Article Talk. Views Read Edit View history. Contribute Help Community portal Recent changes Upload file.
As the access to this document is restricted, you may want to look for a different version below or search for a different version of it. Ryo Kato, Mark L. Gertler, Himmelberg, Stern School of Business, Department of Economics.