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Debt-Ridden Borrowers and Economic Slowdown

Keiichiro Kobayashi and Daichi Shirai

No 17-002E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: Economic growth slows for an extended period after a financial crisis. We construct a model in which the one-time buildup of debt can depress the economy persistently even when there is no shock on financial technology. We consider the debt dynamics of a firm under an endogenous borrowing constraint. When the initial debt is large, the borrowing constraint binds tight and production is inefficient for an extended period. A firm is called debt-ridden when it owes the maximum sustainable amount of debt. A debt-ridden firm pays all income every period as the interest payment on the debt. A noticeable result in the deterministic case is that a debt-ridden firm continues inefficient production permanently. Further, if the initial debt exceeds a certain threshold, the firm chooses to increase borrowing and become debt-ridden intentionally. The emergence of a substantial number of debt-ridden firms lowers economic growth persistently by reducing the growth rate of aggregate productivity. As lenders have no incentive to reduce debt, a policy intervention that provides debtridden borrowers with relief from excessive debt may thus be necessary to restore economic growth.

New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2017-02
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