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Cyclical Fluctuations, Financial Frictions, and Productivity Differences across Firms

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Abstract

Within narrowly defined industries, the most productive firms produce far more than the least productive from the same inputs, and this dispersion widens in downturns. We build a tractable representative-agent model in which financial frictions—adverse selection and moral hazard—make firms sort endogenously into lenders, strategic defaulters, and producers. As credit conditions vary, the resulting misallocation gives aggregate total factor productivity (TFP) an endogenous component that accounts for about 30 percent of the variance of TFP at business-cycle frequencies, a third of it from strategic default. We show that our tractable model can match key features of the observed distribution of productivity across firms and its co-movement with output growth and credit conditions in the data.

Suggested Citation

  • Luca Guerrieri & Jinill Kim & Arsenii Mishin, 2026. "Cyclical Fluctuations, Financial Frictions, and Productivity Differences across Firms," Finance and Economics Discussion Series 2026-047, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:103448
    DOI: 10.17016/FEDS.2026.047
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    References listed on IDEAS

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    1. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
    2. Adjemian, Stéphane & Juillard, Michel & Karamé, Fréderic & Mutschler, Willi & Pfeifer, Johannes & Ratto, Marco & Rion, Normann & Villemot, Sébastien, 2026. "Dynare: Reference Manual, Version 7," Dynare Working Papers 87, CEPREMAP, revised 11 Sep 2026.
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    Keywords

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    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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