Credit chains and the propagation of financial distress

The purpose of this paper is to analyze how shocks propagate through a network of firms that borrow from, and lend to, each other in a trade credit chain, and to quantify the effects of financial contagion across firms. I develop a theoretical model of financial contagion, in which the default of one firm may cause a chain reaction such that its creditors also get into financial difficulties, even though they are sound in the first place. I calibrate and simulate the model using US annual data over the period 1986-2004. At the microeconomic level, I find that, when customers of a sound firm are financially distressed, then this firm gets into financial difficulties with probability that ranges from 4.1% to 12.8% (depending on the business cycle and the underlying economic scenario). Looking at the macroeconomic level, I find that defaults on trade debts lower aggregate GDP by at least 0.4%. During the second half of the 90’s, these deadweight losses doubled and reached a high of 0.9% to 2.3% of GDP (depending on the underlying economic scenario) before the recession of 2001. The results of the simulations also suggest that financial contagion across businesses had been 25% higher during the last recession than during the recession of the early 90’s. JEL Classification: E32, G29, G33business fluctuations, Financial contagion, trade credit

Financial imbalances and financial fragility

This paper develops a general equilibrium model to analyze the link between financial imbalances and financial crises. The model features an interbank market subject to frictions and where two equilibria may (co-)exist. The normal times equilibrium is characterized by a deep market with highly leveraged banks. The crisis times equilibrium is characterized by bank deleveraging, a market run, and a liquidity trap. Crises occur when there is too much liquidity (savings) in the economy with respect to the number of (safe) investment opportunities. In effect, the economy is shown to have a limited liquidity absorption capacity, which depends —inter alia— on the productivity of the real sector, the ultimate borrower. I extend the model in order to analyze the effects of financial integration of an emerging and a developed country. I find results in line with the recent literature on global imbalances. Financial integration permits a more efficient allocation of savings worldwide in normal times. It also implies a current account deficit for the developed country. The current account deficit makes financial crises more likely when it exceeds the liquidity absorption capacity of the developed country. Thus, under some conditions —which this paper spells out— financial integration of emerging countries may increase the fragility of the international financial system. Implications of financial integration and global imbalances in terms of output, wealth distribution, welfare, and policy interventions are also discussed. JEL Classification: E21, F36, G01, G21Asymmetric information, financial crisis, financial integration, global imbalances, Moral Hazard

Trade credit defaults and liquidity provision by firms

Using a unique data set on trade credit defaults among French firms, we investigate whether and how trade credit is used to relax financial constraints. We show that firms that face idiosyncratic liquidity shocks are more likely to default on trade credit, especially when the shocks are unexpected, firms have little liquidity, are likely to be credit constrained or are close to their debt capacity. We estimate that credit constrained firms pass more than one fourth of the liquidity shocks they face on to their suppliers down the trade credit chain. The evidence is consistent with the idea that firms provide liquidity insurance to each other and that this mechanism is able to alleviate the consequences of credit constraints. In addition, we show that the chain of defaults stops when it reaches firms that are large, liquid, and have access to financial markets. This suggests that liquidity is allocated from large firms with access to outside finance to small, credit constrained firms through trade credit chains. JEL Classification: G30, D92, G20credit chains, credit constraints, inter-firm liquidity provision, trade credit

The French block of the ESCB multi-country model

This paper presents the French country block of the ESCB Multi-Country Model for the euro area, which has been built in collaboration by the ECB and the Banque de France. The theoretical structure of the model is in line with most current macroeconometric models, i.e. supply factors determine the long-run equilibrium, while in the short run aggregate demand determines aggregate output. The paper is structured as follows. We first present the theoretical background of the model. Then we review the long run relationships as well as the estimated short term dynamic equations. Finally, we simulate the effects of six exogenous shocks to the economy and discuss the dynamic properties of the model. JEL Classification: C3, C5, E1, E2France, Macro-econometric Modelling

Credit rationing, output gap, and business cycles

The cost-of-financing channel version of the financial accelerator proposed by Bernanke & Gertler [1989] is prominent in the literature. Yet, this particular channel has not been validated by empirical work. This paper presents an alternative version of the accelerator. This new accelerator, based on quantity credit rationing, is shown to be more powerful than the traditional accelerator. By causing factor under-utilization credit rationing generates an output gap persistent and sensitive to technology shocks. This accelerator is not a substitute to the traditional mechanism though, but rather a complement. My model helps improve the understanding of financial transmission mechanisms. It considers several types of collaterals. Financial frictions generate persistence when collaterals take the form of tangible assets. They generate amplification when collaterals take the form of cash flows or when asset prices are variable. JEL Classification: E32, E44

The Dutch block of the ESCB multi-country model

The paper presents the Dutch country block of the ESCB Multi-Country Model (MCM) for the euro area. We show how a theoretical model is translated into an econometric specification and how this specification is in turn estimated and used in the projection exercises of the E(S)CB. The dynamic properties of the model are analyzed and the effects of six exogenous shocks to the economy discussed. The long run simulations performed deliver responses of the baseline economy in line with both macroeconomic theory and practice, from a quantitative and a qualitative point of view. JEL Classification: C3, C5, E1, E2forecast, Multi-country model, Netherlands, Simulation

Monetary Policy and Endogenous Financial Crises

We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course

Marchés financiers, croissance et fluctuations : quelques repères

Cahiers Eco & Maths 1997.47The financial deregulation is generally considered as stimulating the economic growth; but it is also said to play a role in the short run -excessive- fluctuations. In this work, we point out some recent and important theoretical points that allow for analysing the links between financial markets, growth, and business cycles.La déréglementation financière est le plus souvent présentée comme un phénomène bénéfique à la croissance ; mais on lui attribue également une part de responsabilité dans les fluctuations économiques de court terme liées aux marchés financiers. Ce travail propose quelques points de repère sur les développements théoriques de ces dernières années concernant les liens entre marchés financiers, croissance et cycle économique