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Firm Dynamics and Growth with Soft Budget Constraints

Author

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  • Aghion, Philippe
  • Bergeaud, Antonin
  • Dewatripont, Mathias
  • Matt, Johannes

Abstract

We study how financial conditions shape firm dynamics and economic growth. We develop a Schumpeterian growth model in which limited commitment in debt markets gives rise to a soft budget constraint syndrome. Because financiers cannot commit not to refinance underperforming innovators, funding may be misallocated. Tighter financial conditions reallocate resources toward entry but reduce incumbent innovation, generating a hump-shaped relationship between refinancing costs and growth. We characterize the optimal refinancing policy and show that it depends critically on the elasticity of entry. Calibrating the model to French firm-level data, we find that the optimal response to a refinancing cost shock is to ease refinancing conditions, preserving incumbent innovation at the expense of lower entry and substantially mitigating the resulting growth and welfare losses.

Suggested Citation

  • Aghion, Philippe & Bergeaud, Antonin & Dewatripont, Mathias & Matt, Johannes, 2025. "Firm Dynamics and Growth with Soft Budget Constraints," CEPR Discussion Papers 19996, Centre for Economic Policy Research.
    • Handle: RePEc:cpr:ceprdp:19996
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    JEL classification:

    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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