Working Paper: CEPR ID: DP16720
Authors: Vladimir Asriyan; Luc Laeven; Alberto MartÃn; Alejandro Van der Ghote; Victoria Vanasco
Abstract: We show that in a canonical model with heterogeneous entrepreneurs, financial frictions, and an imperfectly elastic supply of capital, a fall in the interest rate has an ambiguous effect on aggregate economic activity. In partial equilibrium, a lower interest rate raises aggregate investment both by relaxing financial constraints and by prompting relatively less productive entrepreneurs to invest. In general equilibrium, however, this higher demand for capital raises its price and crowds out investment by more productive entrepreneurs. When this reallocation is strong enough, a fall in the interest rate reduces aggregate output. A numerical exploration of the model suggests that this reallocationeffect is quantitatively significant and - in response to persistent changes in the interest rate - stronger than the traditional balance-sheet channel. We provide evidence of the reallocation effect using US firm-level data.
Keywords: low interest rates; financial frictions; firm heterogeneity; allocation; credit; asset prices; balance sheet channel; optimal monetary policy
JEL Codes: E22; E32; E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decrease in interest rates (E43) | Reallocation of capital from more productive to less productive entrepreneurs (D29) |
| Reallocation of capital from more productive to less productive entrepreneurs (D29) | Reduction in aggregate output (E23) |
| Decrease in interest rates (E43) | Reduction in aggregate output (E23) |
| Decrease in interest rates (E43) | Increase in investment from less productive entrepreneurs (O49) |
| Increase in investment from less productive entrepreneurs (O49) | Crowding out of investment from more productive entrepreneurs (E22) |