A Schumpeterian view of business cycles and growth, is that recessions provide a cleansing mechanism for correcting organizational inefficiencies and for encouraging firms to reorganize, innovate or reallocate to new markets. The cleansing effect of recessions is also to eliminate those firms that are unable to reorganize or innovate. Schumpeter himself would summarize that view as follows; “[Recessions] are but temporary.
They are means to reconstruct each time the economic system on a more efficient plan”. This of course assumes that firms can always borrow enough funds to either reorganize their activities or move to new activities and markets. Without credit constraints, investment choices are indeed dictated by an opportunity-cost effect: namely, the opportunity cost of long-term innovative investments instead of short-term capital investments, is lower in recessions than in booms. Hence, the share of long-term investment in total investment should be countercyclical, whereas the share of short-term investment is procyclical (see Hall (1993), Gali and Hammour (1992), Aghion and Saint-Paul (1998), Bean (1990), Bloom (2007)).
There’s a agreement that there exists a strong link between too much regulation, called “market frictions”, and economic under-performance. Indeed, a growing body of literature claims market frictions are to blame for the divergent performance in productivity and employment of continental European versus US economies during the 80s and 90s. But, if European markets should be deregulated, why doesn’t it happen? While product market reforms are slow-moving in Europe and some sectors are still virtually served by monopolies, labour market deregulation is even less pronounced (Gönenç et al., 2000).
Over the last decade, subprime mortgage lending has become an important component of the overall mortgage market. Subprime mortgage lending increased from $90 billion in 1996 to over $173 billion in 2001 and accounted for 8.3 percent of the overall mortgage market in 2001. (See Figure 1.) Subprime mortgage lending serves a critical role in the nation’s economy by providing loans to borrowers who do not meet the credit standards for borrowers in the prime market. These borrowers may have blemishes in their credit record, insufficient credit history, or non-traditional credit sources. Subprime lending allows such borrowers to access credit that they could not otherwise obtain in the prime credit market.
