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Breaking the spell with credit-easing : self-confirming credit crises in competitive search economies

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  • Gaballo, Gaetano; Marimon, Ramon
Abstract
We show that credit crises can be Self-Confirming Equilibria (SCE), which provides a new rationale for policy interventions like, for example, the FRB’s TALF credit-easing program in 2009.We introduce SCE in competitive credit markets with directed search. These markets are efficient when lenders have correct beliefs about borrowers’ reactions to their offers. Nevertheless, credit crises – where high interest rates self-confirm high credit risk - can arise when lenders have correct beliefs only locally around equilibrium outcomes. Policy is needed because competition deters the socially optimal degree of information acquisition via individual experiments at low interest rates. A policy maker with the same beliefs as lenders will find it optimal to implement a targeted subsidy to induce low interest rates and, as a by-product, generate new information for the market. We provide evidence that the 2009 TALF was an example of such Credit Easing policy. We collect new micro-data on the ABS auto loans in the US before and after the policy intervention, and we test, successfully, our theory in this case.

Suggested Citation

  • Gaballo, Gaetano; Marimon, Ramon, 2016. "Breaking the spell with credit-easing : self-confirming credit crises in competitive search economies," Economics Working Papers ADE2016/01, European University Institute.
    • Handle: RePEc:eui:euiwps:ade2016/01
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    Cited by:

    1. Straub, Ludwig & Ulbricht, Robert, 2015. "Endogenous Uncertainty and Credit Crunches," TSE Working Papers 15-604, Toulouse School of Economics (TSE), revised Dec 2017.
    2. Corsetti, Giancarlo & Brendon, Charles, 2016. "COEURE Survey: Fiscal and Monetary Policies after the Crises," CEPR Discussion Papers 11088, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    unconventional policies; learning; credit crisis; social experimentation; self-confirming; equilibrium; directed search;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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