Financial intermediation and regime switching in business cycles

We study a one-sector growth model where capital investment is credit financed, and there is an adverse selection problem in credit markets. The presence of adverse selection creates an indeterminacy of equilibrium, Many equilibria display permanent fluctuations characterized by transitions between Walrasian regimes and regimes of credit rationing. Cyclical contractions involve declines in real interest rates, increases in credit rationing, and withdrawals of savings from banks. For some configurations of parameters all equilibria display cyclical fluctuations. We provide sufficient conditions for deterministic cycles consisting of m periods of expansion followed by n periods of contraction to exist.