Financial Constraints, Endogenous Markups, and Self-fulfilling Equilibria

By Jess Benhabib and Pengfei Wang

http://d.repec.org/n?u=RePEc:nbr:nberwo:18074&r=dge

We show that self-fulfilling equilibria and indeterminacy can easily arise in a simple financial accelerator model with reasonable parameter calibrations and without increasing returns in production. A key feature for generating indeterminacy in our model is the countercyclical markup due to the procyclical loan to output ratio. We illustrate, via simulations, that our financial accelerator model can generate rich business cycle dynamics, including hump-shaped output in response to demand shocks as well as serial autocorrelation in output growth rates.

Not only is it easy to generate self-fulfilling and multiple equilibria, they are also perfectly in line with important observations. And tghe basis is the financial accelerator model that has been used so much over the last two decades. Well, that was easy to answer all the critics…