Debt-Ridden Borrowers and Productivity Slowdown
Keiichiro Kobayashi and
No 14-005E, CIGS Working Paper Series from The Canon Institute for Global Studies
Many authors argue that financial constraints have been tightened in several countries since the Great Recession in 2007–2009. To explain this, we construct a model in which borrowing constraints for firms are tightened as a result of mass default due to a bubble collapse. In Jermann and Quadrini's (2012) model, a defaulting firm either goes back to being a normal firm by (partially) repaying its debt or is liquidated. We assume that there is an intermediate status: a "debt-ridden" firm, defined as a firm whose lender retains the right to liquidate it. The lender allows the debt-ridden firm to continue if it pays continuation fee. In our model, debt forgiveness is infeasible: once a firm defaults on the debt, it is either liquidated or kept as a debt-ridden firm. The defaulter cannot go back to being a normal firm, unless it repays all its debt. Prohibition of debt forgiveness can be justified as a collective choice of the society, in order to expand the borrowing limit for normal firms. It is shown that borrowing constraints are tighter for debt-ridden than for normal firms. This implies that the emergence of a large mass of debt-ridden borrowers may be a cause of the "financial shocks" discussed in recent macroeconomic literature. Tightened borrowing constraints due to the emergence of debt-ridden firms lower the aggregate productivity. This negative effect on productivity can be permanent. In a version of the model with endogenous growth, the growth rate of aggregate productivity becomes zero if the number of debt-ridden firms exceeds a certain threshold.
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Working Paper: Debt-Ridden Borrowers and Productivity Slowdown (2016)
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