Accounting and Finance Seminar - Peter Kondor (LSE)

30 October 2019, 1.00 PM - 30 October 2019, 2.15 PM

Peter Kondor

G.15, 15-19 Tyndalls Park Road

Rational Sentiments and Economic Cycles

Abstract 

We propose a rational model of endogenous credit cycles generated by the two-way interaction of credit market sentiments and real outcomes. Sentiments are high when most lenders optimally choose lax lending standards. This leads to low interest rates and high output growth, but also to the deterioration of future credit application quality. When the quality is sufficiently low, lenders endogenously switch to tight standards, i.e. sentiments become low. This implies high credit spreads, low quantity of issued credit and a gradual improvement in the quality of applications, which eventually triggers a shift to lax lending standards. The equilibrium cycle might feature a long boom or a lengthy, possibly double-dip recession. It is generically different from the optimal cycle as atomistic lenders ignore their aggregate effect on the composition of borrowers. Carefully chosen risk-weighted capital requirements can often improve the decentralized equilibrium cycle.

 

Contact information

http://personal.lse.ac.uk/kondor/

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