Working Paper: CEPR ID: DP4173
Authors: Thomas F. Cooley; Ramon Marimon; Vincenzo Quadrini
Abstract: We study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts. Because of enforceability problems, contracts are constrained efficient. We show that limited enforceability amplifies the impact of technological innovations on aggregate output. More generally, we show that lower enforceability of contracts will be associated with greater aggregate volatility. A key assumption for this result is that defaulting entrepreneurs are not excluded from the market.
Keywords: aggregate volatility; amplification; contract enforceability
JEL Codes: E30; G00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lower contract enforceability (K12) | Greater aggregate volatility (E19) |
| Limited enforceability amplifies the impact of technological innovations (O39) | Greater volatility in output (E32) |
| Defaulting entrepreneurs not excluded from the market (M13) | Greater capital allocation to firms (G32) |
| Emergence of more productive technology (O49) | Increased value of new investment projects (G31) |
| Lower contract enforceability (K12) | Higher standard deviations in GDP growth (O49) |