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Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations

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  • Thomas Drechsel

Abstract

Micro evidence on US corporate borrowing suggests a strong connection between firms' current earnings and their access to debt. This paper formalizes this link through an earnings-based constraint on firm borrowing and studies its macroeconomic implications. Introducing the proposed constraint in a business cycle model alters the transmission of shocks relative to an asset-based collateral constraint, which has become a standard building block in macroeconomics. In response to positive investment shocks, corporate debt expands when earnings-based constraints are present, while it contracts with collateral constraints, as the shock reduces the relative value of capital. The paper empirically verifies these theoretical predictions using both aggregate and firm-level data. The responses of debt to investment shocks in the data support the aggregate relevance of the earnings-based constraint, and heterogeneous borrowing dynamics at the firm-level are in line with the mechanism. In an estimated quantitative model with nominal rigidities, earnings-based constraints dampen the output response to fiscal shocks, whereas monetary shocks have stronger but less persistent effects relative to counterfactual estimations without the constraint.

Suggested Citation

  • Thomas Drechsel, 2018. "Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations," 2018 Papers pdr141, Job Market Papers.
  • Handle: RePEc:jmp:jm2018:pdr141
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    File URL: https://ideas.repec.org/jmp/2018/pdr141.pdf
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    References listed on IDEAS

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    Cited by:

    1. James Cloyne & Clodomiro Ferreira & Maren Froemel & Paolo Surico, 2018. "Monetary Policy, Corporate Finance and Investment," NBER Working Papers 25366, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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