EQUILIBRIUM LENDING MECHANISM AND AGGREGATE ACTIVITY

We construct a model of the credit market where financial contracting is subject to costly state verification and moral hazard. The economy's aggregate activity and its equilibrium lending mechanism are determined jointly. We analyze how changes in the model's exogenous variables, including the returns of the economy's investment projects and the supply of loans, affect the economy's aggregate output and the types of the credit through which investment is funded. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.