Kiyotaki–Moore Model

Published Mar 22, 2024

Definition of the Kiyotaki–Moore model

The Kiyotaki–Moore model, developed by Nobuhiro Kiyotaki and John Moore, is a theoretical framework within economics that addresses the interactions between credit constraints, economic cycles, and land as collateral. This model illustrates how fluctuations in the value of land or assets used as collateral can amplify and propagate business cycles, particularly through their effect on borrowing and lending. The central insight of the Kiyotaki–Moore model is that because the value of collateral (such as land) can change, it affects the borrowing capacity of individuals and firms, leading to a cyclical process that can either exacerbate or mitigate economic fluctuations.

Example

To understand the Kiyotaki–Moore model, consider a simplified scenario in which farmers use their land as collateral to borrow money for planting crops. When the economy is strong, land values increase, allowing farmers to borrow more money. This additional borrowing capacity can be used to expand operations, buy more land, or invest in technology, further stimulating economic growth. However, if an economic downturn occurs and land values decrease, farmers find their borrowing capacity severely restricted. This limitation can force them to scale back operations or sell land to meet their debt obligations, exacerbating the downturn by leading to a decrease in production and increase in unemployment, further depressing land values in a vicious cycle.

Why the Kiyotaki–Moore Model Matters

The significance of the Kiyotaki–Moore model lies in its ability to capture the dynamic relationship between asset prices, borrowing, and economic activity, providing insights into how credit market imperfections can lead to persistent and volatile economic cycles. By highlighting the role of collateral in the financial system, this model has important implications for understanding financial crises, where a drop in asset prices can lead to a sharp contraction in lending and a severe economic downturn. Policymakers can use insights from the Kiyotaki–Moore model to design interventions that stabilize asset prices or directly address the amplification mechanisms in credit markets, potentially mitigating the severity of economic cycles.

Frequently Asked Questions (FAQ)

How does the Kiyotaki–Moore model differ from traditional models of economic cycles?

The Kiyotaki–Moore model diverges from traditional models by emphasizing the role of credit constraints and collateral in driving economic cycles. While classical models often focus on factors such as technology shocks or policy changes, the Kiyotaki–Moore framework centers on the financial sector’s dynamics, specifically the interaction between asset prices and borrowing capacity, which can lead to self-reinforcing cycles independent of external shocks.

Can the Kiyotaki–Moore model explain financial crises?

Yes, the Kiyotaki–Moore model is particularly relevant for understanding financial crises. It shows how a decrease in asset prices (e.g., real estate) can rapidly erode the value of collateral, leading to a contraction in credit and a subsequent downturn in economic activity. This process can accelerate if asset sales to cover loans lead to further declines in prices, creating a feedback loop that results in a severe financial and economic crisis.

What policy implications can be drawn from the Kiyotaki–Moore model?

The Kiyotaki–Moore model suggests that policies aimed at stabilizing asset prices or directly addressing credit market imperfections can be effective in smoothing economic cycles. For example, central banks might implement policies to ensure liquidity in credit markets during downturns, preventing a rapid devaluation of collateral and a collapse in lending. Additionally, regulations that limit excessive borrowing against volatile assets could reduce the economy’s susceptibility to the kind of cycles described by the model.

In summary, the Kiyotaki–Moore model offers a sophisticated lens through which to view the interplay between credit markets and economic cycles, highlighting the critical role of collateral in financial stability and economic performance. By understanding the dynamics outlined in this model, policymakers and economists can better prepare for and mitigate the impacts of economic downturns and financial crises.