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Limited Commitment, Firm Dynamics and Aggregate Fluctuations

  • Alexander Monge-Naranjo

    (Northwestern University)

Limitations in the punishment for default induce constraints in the credit of firms and a non-trivial dynamics for their growth. Those limitations can also shape the dynamic response of the overall economy in response to an aggregate shock. In this paper I consider a simple continuous time formulation of the optimal dynamic relationship between a banks and a firm and derive a simple and sharp characterization of the optimal contract, the implicit credit constraints (for an equivalent sequentail trading arrangment) and the implied firm dynamics. I analytically characterize the steady state firm size distribution and show how to solve the optimal contract under any arbitrary deterministic path of the economy-wide equilibrium prices. I use the results to study the aggregate response to interest rates and aggregate productivity fluctuations. I also study the output and welfare cost of limited commitment.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 964.

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Date of creation: 2008
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Handle: RePEc:red:sed008:964
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  1. Evans, David S, 1987. "Tests of Alternative Theories of Firm Growth," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 657-74, August.
  2. Gertler, M. & Gilchrist, S., 1993. "Monetary Policy, Business Cycles and the Behavior of Small Manufacturing Firms," Working Papers 93-02, C.V. Starr Center for Applied Economics, New York University.
  3. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
  4. Evans, David S, 1987. "The Relationship between Firm Growth, Size, and Age: Estimates for 100 Manufacturing Industries," Journal of Industrial Economics, Wiley Blackwell, vol. 35(4), pages 567-81, June.
  5. Jeremy Bulow & Kenneth Rogoff, 1998. "Sovereign Debt: Is to Forgive to Forget," Levine's Working Paper Archive 209, David K. Levine.
  6. Oliver Hart & John Moore, 1991. "A Theory of Debt Based on the Inalienability of Human Capital," NBER Working Papers 3906, National Bureau of Economic Research, Inc.
  7. Hall, Bronwyn H, 1987. "The Relationship between Firm Size and Firm Growth in the U.S. Manufacturing Sector," Journal of Industrial Economics, Wiley Blackwell, vol. 35(4), pages 583-606, June.
  8. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  9. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  10. Dunne, Timothy & Roberts, Mark J & Samuelson, Larry, 1989. "Plant Turnover and Gross Employment Flows in the U.S. Manufacturing Sector," Journal of Labor Economics, University of Chicago Press, vol. 7(1), pages 48-71, January.
  11. Dunne, Timothy & Roberts, Mark J & Samuelson, Larry, 1989. "The Growth and Failure of U.S. Manufacturing Plants," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 671-98, November.
  12. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
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