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The Equilibrium Impact of Credit Frictions: Evidence from Default Risk Using Firm-Level Data

Author

Listed:
  • Besley, Timothy

    (London School of Economics)

  • Lambert, Peter John

    (London School of Economics and University of Warwick and CAGE)

  • Michalski-Roland, Isabelle

    (Bank of England)

  • Van Reenen, John

    (London School of Economics)

Abstract

This paper examines the impact of credit frictions arising from firm-level default risk on aggregate economic performance. We build a micro-to-macro model with heterogeneous firms and sector-specific production functions, showing that perceived default risk is a sufficient statistic for credit frictions. Using UK administrative data (2004-2019) matched to S&P risk measures, counterfactual estimates reveal that relaxing frictions raises output by 25% and wages by 23%. Ignoring equilibrium wage adjustments overstates output gains, while fixed-capital misallocation approaches understate them. Most gains reflect aggregate capital accumulation. Credit frictions remain above pre-crisis levels, reshape firm size dynamics, increase misallocation across firms, and dampen productivity growth over time.

Suggested Citation

  • Besley, Timothy & Lambert, Peter John & Michalski-Roland, Isabelle & Van Reenen, John, 2026. "The Equilibrium Impact of Credit Frictions: Evidence from Default Risk Using Firm-Level Data," CAGE Online Working Paper Series 818, Competitive Advantage in the Global Economy (CAGE).
    • Handle: RePEc:cge:wacage:818
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    References listed on IDEAS

    as
    1. Norris Keiller, Agnes & De Paula Neto, Aureo & Van Reenen, John, 2024. "Production function estimation using subjective expectations data," LSE Research Online Documents on Economics 126812, London School of Economics and Political Science, LSE Library.
    2. Agnes Norris Keiller & Áureo de Paula & John Van Reenen, 2024. "Production function estimation using subjective expectations data," IFS Working Papers WCWP15/24, Institute for Fiscal Studies.
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    5. Gabriel Chodorow-Reich, 2014. "The Employment Effects of Credit Market Disruptions: Firm-level Evidence from the 2008-9 Financial Crisis," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(1), pages 1-59.
    6. Kilian Huber, 2018. "Disentangling the Effects of a Banking Crisis: Evidence from German Firms and Counties," American Economic Review, American Economic Association, vol. 108(3), pages 868-898, March.
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    Keywords

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    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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