Working Paper: NBER ID: w17311
Authors: Aubhik Khan; Julia K. Thomas
Abstract: We study the cyclical implications of credit market imperfections in a calibrated dynamic, stochastic general equilibrium model wherein firms face persistent shocks to aggregate and individual productivity. In our model economy, optimal capital reallocation is distorted by two frictions: collateralized borrowing and partial capital irreversibility yielding (S,s) firm-level investment policies. \n \nIn the presence of persistent heterogeneity in capital, debt and total factor productivity, the effects of a financial shock are amplified and propagated through large and long-lived disruptions to the distribution of capital that, in turn, imply large and persistent reductions in aggregate total factor productivity. We find that an unanticipated tightening in borrowing conditions can, on its own, generate a large recession far more persistent than the financial shock itself. This recession, and the subsequent recovery, is distinguished both quantitatively and qualitatively from that driven by exogenous shocks to total factor productivity.
Keywords: credit shocks; aggregate fluctuations; dynamic stochastic general equilibrium; production heterogeneity
JEL Codes: E22; E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tightening in borrowing conditions (F65) | Distribution of capital (D33) |
| Distribution of capital (D33) | Aggregate total factor productivity (TFP) (E23) |
| Tightening in borrowing conditions (F65) | Aggregate total factor productivity (TFP) (E23) |
| Credit shock (F65) | Large recession (E32) |
| Credit shock (F65) | Persistent reductions in aggregate total factor productivity (TFP) (O49) |
| Credit shock (F65) | Disruptions in capital distribution (D39) |
| Credit shock (F65) | Slow recovery led by employment and business fixed investment (E20) |