Amplifying Business Cycles Through Credit Constraints

Theory suggests that endogenous borrowing constraints amplify the impact of external shocks on the economy. How big is the amplification? In this paper, the authors quantitatively investigate this question in the context of a dynamic general equilibrium model with borrowing constraints under two alternatives: borrowing constraint endogenously depends on the borrowers' net worth borrowing constraint is exogenous. Calibrating the model to the Japanese economy, they find evidence of significant amplification. Next, they apply the model to Japan and find that TFP fluctuations can well account for the boom and the bust of the Japanese economy during 1980 to 2000, and the impact is much more significant when borrowing constraint is endogenous.