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Financial Frictions in Production Networks

Author

Listed:
  • Saki Bigio

    (UCLA and NBER)

  • Jennifer La’O

    (Columbia University and NBER)

Abstract

We study how an economy’s production structure determines the response of aggregate output and employment to sectoral financial shocks. In our framework, economic production is organized in an input-output network in which firms face financial constraints on their working capital. We show how sectoral financial shocks propagate through the network and manifest at the aggregate level through two channels: a fall in total factor productivity and an aggregate labor wedge distortion. The strength of each channel depends on the overall network architecture and the location of shocks. Finally, we calibrate our model to the U.S. input-output tables and use it to quantitatively assess the role of the network multiplier within the context of the recent Financial Crisis and the Great Recession.

Suggested Citation

  • Saki Bigio & Jennifer La’O, 2016. "Financial Frictions in Production Networks," Working Papers 2016-67, Peruvian Economic Association.
  • Handle: RePEc:apc:wpaper:2016-067
    as

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    References listed on IDEAS

    as
    1. Andrew T. Foerster & Pierre-Daniel G. Sarte & Mark W. Watson, 2011. "Sectoral versus Aggregate Shocks: A Structural Factor Analysis of Industrial Production," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 1-38.
    2. Saki Bigio, 2015. "Endogenous Liquidity and the Business Cycle," American Economic Review, American Economic Association, vol. 105(6), pages 1883-1927, June.
    3. Ezra Oberfield, 2011. "Business networks, production chains and productivity: A theory of input-output architecture," Working Paper Series WP-2011-12, Federal Reserve Bank of Chicago.
    4. Enghin Atalay, 2017. "How Important Are Sectoral Shocks?," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(4), pages 254-280, October.
    5. Christoph E. Boehm & Aaron Flaaen & Nitya Pandalai-Nayar, 2019. "Input Linkages and the Transmission of Shocks: Firm-Level Evidence from the 2011 Tōhoku Earthquake," The Review of Economics and Statistics, MIT Press, vol. 101(1), pages 60-75, March.
    6. Loukas Karabarbounis, 2014. "The Labor Wedge: MRS vs. MPN," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 206-223, April.
    7. Shaowen Luo, 2020. "Propagation of Financial Shocks in an Input-Output Economy with Trade and Financial Linkages of Firms," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 36, pages 246-269, April.
    8. Zetlin-Jones, Ariel & Shourideh, Ali, 2017. "External financing and the role of financial frictions over the business cycle: Measurement and theory," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 1-15.
    9. David Rezza Baqaee, 2018. "Cascading Failures in Production Networks," Econometrica, Econometric Society, vol. 86(5), pages 1819-1838, September.
    10. Dupor, Bill, 1999. "Aggregation and irrelevance in multi-sector models," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 391-409, April.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Production Networks; Financial Frictions; Business Cycles;
    All these keywords.

    JEL classification:

    • C67 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Input-Output Models
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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