Ebook The Financial Accelerator in Household Spending: Evidence from International Housing Markets
Recent theoretical research proposes that endogenous developments in financial markets can greatly amplify and propagate small income or interest rate shocks throughout the economy (Kiyotaki and Moore, 1997; and Bernanke, Gertler, and Gilchrist, 1996, 1999). Bernanke et al. (1996) call this amplification mechanism the 0financial accelerator1 or 0credit multiplier. The key idea behind the financial accelerator is the notion that shocks to the net worth of firms and households have a procyclical effect on their borrowing capacity.
This could happen either because the information cost wedge between external and internal finance moves countercyclically (Bernanke and Gertler, 1989), or because a procyclical change in the value of collateralizable assets changes the amount of collateralized external finance in the same direction (Kiyotaki and Moore, 1997). Following a positive income shock, agents should be able to raise more external finance and the increase in borrowing capacity would further boost investment spending. According to this view, financial mechanisms such as the endogenous procyclicality of external financing capacity can help explain important features of the business cycle and the transmission of monetary policy.
There is little direct evidence on the amplification mechanism which underlies the financial accelerator. Most empirical studies use firm data to explore one insight behind the accelerator: income shocks should affect corporate spending only when firms have imperfect (constrained) access to external finance. Empirically, the investment spending of financially constrained firms should be more sensitive to changes in net worth than the investment spending of unconstrained firms (Fazzari, Hubbard, and Petersen, 1988).
In the same vein, constrained firms spending and borrowing should fluctuate relatively more in the aftermath of monetary and other macroeconomic shocks (Gertler and Gilchrist, 1993, 1994). Unfortunately, while comparisons between constrained and unconstrained firms may indicate whether one groups spending is more dependent on current income following an economic shock, they will not identify whether differences in spending stem from an endogenous financial amplification mechanism: because constrained firms are more dependent on current income for investment funding, they should be more sensitive to a shock that affects income even when the shock has no cyclical effect on their borrowing capacity.
So how can one identify whether there is an independent spending effect coming from an endogenous change in borrowing capacity following a shock? The theory suggests that the quantitative effect of an aggregate income shock on constrained agents spending would be greater when debt capacity is procyclical. Hence one testing approach consists of directly quantifying the overall magnitude of the amplification effect for constrained firms with procyclical net worth; this is the spirit of the simulation exercises in Bernanke et al. (1999). An alternative approach is to gauge the degree of procyclicality in agents borrowing capacity and then pin down the dynamics of the financial accelerator by looking at cross sectional differences in the spending responses to economic shocks among strictly constrained, cyclical agents. We pursue such an approach in this paper.
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