The Asymmetric Effects of Financial Frictions

Economic variables are known to move asymmetrically over the business cycle: quickly and sharply during crises, but slowly and gradually during recoveries. Not known is the fact that this asymmetry is stronger in countries with less-developed financial systems. This new fact is documented using cross-country data on loan interest rates, investment, and output. The fact is then explained using a learning model with endogenous flows of information about economic conditions. Asymmetry is shown to be stronger in less-developed countries because these countries have greater financial frictions, which are captured in the model by higher monitoring and bankruptcy costs. These greater frictions magnify the crisis reactions of lending rates and economic activity to shocks and then delay their recovery by restricting the generation of information after the crisis. Empirical evidence and a quantitative exploration of the model show that this explanation is consistent with the data.