Credit Shocks in an Economy with Heterogeneous Firms and Default

Tatsuro Senga, Julia Thomas and Aubhik Khan

No 1311, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We consider business cycles driven by exogenous changes in total factor productivity and by credit shocks. The latter are financial shocks that worsen borrowers cash on hand and reduce the fraction of collateral lenders can seize in the event of default. Our nonlinear loan rate schedules drive countercyclical default risk and exit. Because a negative productivity shock raises default probabilities, it leads to a modest reduction in the number of firms and a deterioration in the allocation of capital that amplifies the effect of the shock. The recession following a negative credit shock is qualitatively different from that following a productivity shock. A rise in default alongside a substantial fall in entry causes a large decline in the number of firms. Measured TFP falls for several periods, as does employment, investment and GDP. The recovery following a credit shock is gradual given slow recoveries in TFP, aggregate capital, and the measure of firms.

Date: 2014
New Economics Papers: this item is included in nep-ban and nep-dge
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