The Dynamic Effects of Firm-Level Borrowing Constraints

In this paper, I develop a detailed dynamic model of firm behavior in order to see whether financial constraints and endogenous exit are important propagation mechanisms. To do this, I construct an economy where firms face financial constraints, fixed costs, and persistent idiosyncratic shocks. Using numerical methods, I analyze how a large collection of these firms responds to aggregate productivity shocks. A common result is that financial constraints tend to dampen the economy's initial response to aggregate productivity shocks but equity accumulation and exit dynamics amplify the longer-term response. The relative sizes of these two effects, however, are sensitive to firms' environments.