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Macroeconomic Effects of Delayed Capital Liquidation

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  • Wei Cui

Abstract

This paper studies the macroeconomic effects of capital reallocation with financial shocks. I develop a model in which firms face borrowing constraints, idiosyncratic productivity shocks, and idiosyncratic liquidation costs. The idiosyncratic risks of productivity and liquidation costs generate an option value of staying in business and a liquidation delay for unproductive firms. A new feature arises from the delay. Unproductive firms that are not liquidated increase their leverage over time, pushing them to hit the borrowing limit. I show that adverse financial shocks that tighten borrowing constraints can raise the option value, and equilibrium effects can further delay capital liquidation and reallocation. Capital is thus persistently misallocated, leading to long-lasting economic contractions.

Suggested Citation

  • Wei Cui, 2022. "Macroeconomic Effects of Delayed Capital Liquidation," Journal of the European Economic Association, European Economic Association, vol. 20(4), pages 1683-1742.
    • Handle: RePEc:oup:jeurec:v:20:y:2022:i:4:p:1683-1742.
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    File URL: http://hdl.handle.net/10.1093/jeea/jvac023
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    References listed on IDEAS

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    Cited by:

    1. Wei Cui & Randall Wright & Yu Zhu, 2022. "Endogenous Liquidity and Capital Reallocation," Staff Working Papers 22-27, Bank of Canada.
    2. Christian Keuschnigg & Michael Kogler & Johannes Matt, 2022. "Banks, Credit Reallocation, and Creative Destruction," Swiss Finance Institute Research Paper Series 22-83, Swiss Finance Institute.
    3. Guerrazzi, Marco & Candido, Giuseppe, 2023. "The determination of the price of capital goods: A differential game approach," MPRA Paper 119118, University Library of Munich, Germany.

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