The net worth trap: investment and output dynamics in the presence of financing constraints

Jukka Isohätälä, Alistair Milne and Donald Robertson

No 26/2014, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We study the impact of financing constraints on investment and output dynamics, in a continuous time setting with output a linear function of capital. Decline of net worth reduces investment and, if firms can rent capital to unconstrained outside investors, can create a 'net worth trap' with both investment and output falling below normal levels for long time periods. We provide a detailed account of our model solution and discuss both the economic intuition underpinning our results and the implications for macroeconomic modeling.

Keywords: cash flow management; corporate prudential risk; financial accelerator; financial distress; induced risk aversion; liquidity constraints; liquidity risk; macroeconomic propagation; multiperiod financial management; non-linear macroeconomic modelling; Tobin's q; precautionary savings (search for similar items in EconPapers)
JEL-codes: E44 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: The Net Worth Trap: Investment and Output Dynamics in the Presence of Financing Constraints (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2014_026

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