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Debt-Ridden Borrowers and Productivity Slowdown

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  • Keiichiro Kobayashi
  • Daichi Shirai

Abstract

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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Bibliographic Info

Paper provided by The Canon Institute for Global Studies in its series CIGS Working Paper Series with number 14-005E.

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Length: 38
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:cnn:wpaper:14-005e

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  1. Fumio Hayashi & Edward C. Prescott, 2002. "Data Appendix to The 1990s in Japan: A Lost Decade," Technical Appendices hayashi02, Review of Economic Dynamics.
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  3. Carmen M. Reinhart & Vincent R. Reinhart, 2010. "After the Fall," NBER Working Papers 16334, National Bureau of Economic Research, Inc.
  4. Urban Jermann & Vincenzo Quadrini, 2006. "Financial Innovations and Macroeconomic Volatility," NBER Working Papers 12308, National Bureau of Economic Research, Inc.
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  10. repec:hal:cesptp:hal-00680634 is not listed on IDEAS
  11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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  15. Nishimura, Kiyohiko G. & Nakajima, Takanobu & Kiyota, Kozo, 2005. "Does the natural selection mechanism still work in severe recessions?: Examination of the Japanese economy in the 1990s," Journal of Economic Behavior & Organization, Elsevier, vol. 58(1), pages 53-78, September.
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