A Simple Macroeconomic Model with Endogenous Credit Rationing

In this paper, a two-period macroeconomic model, in which output is demand determined, is constructed. In the first period firms may borrow to finance investment, which reduces their marginal costs in the second period; however, since default by borrowers is possible there is an incentive compatibility constraint which may or may not bind. If it binds, there is endogenous credit rationing. Three regimes are possible; in Regime I there is no investment; in Regime II there is positive investment without the ICC holding, whereas in the third the condition binds and there is credit rationing. The behaviour of the economy in each of these regimes, and the circumstances under which each of these regimes obtains, are analyzed and some conclusions drawn. The possibility that the model possesses multiple equilibria is considered.