Do Credit Constraints Amplify Macroeconomic Fluctuations?

Abstract

Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This pa- per argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a DSGE model: we identify shocks that shift the demand for collateral assets and we allow productive agents to be credit-constrained. A combination of these two features enables our model to successfully generate an empirically impor- tant mechanism that amplifies and propagates macroeconomic fluctuations through credit constraints.