Consumption habits and interest rate rigidity

Abstract

In this paper we provide a micro model of loans which the lender is a monopolistic bank and the borrower is a competitive consumer with consumption habits who may default on part of his debt. In this setting, we prove that the loan demand curve is kinked and therefore it is possible to find interest rate rigidity in equilibrium as well as asymmetric response of loans to interest rate variations. Finally, we show through an example that the credit supply, as a function of the marginal cost of the bank, exhibits a discontinuity on that marginal cost. As a consequence, lowering the basic interest rate of the economy may produce a sudden increase in credit demand/supply and in the default on debts.