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Collateral constraints, capital specificity and the distribution of production: the role of real and financial frictions in aggregate fluctuations

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  • Julia K. Thomas

    (The Ohio State University and NBER)

  • Aubhik Khan

    (The Ohio State University)

Abstract

We study the cyclical implications of credit market imperfections in a dynamic, stochastic general equilibrium model wherein firms face persistent shocks to both aggregate and individual productivity. In our model economy, optimal capital reallocation is distorted by two frictions. First, collateralized borrowing constraints limit the investment undertaken by small firms with relatively high productivities. Second, a quasi-specificity in firm-level capital implies investment irreversibilities that lead firms to pursue generalized (S,s) investment rules. This second friction compounds the first in implying that large and relatively unproductive firms carry a disproportionate share of the aggregate capital stock, thereby reducing endogenous aggregate total factor productivity. Moreover, because irreversibilities not only directly induce both downward and upward inertia in firm-level capital adjustment, but also tighten the borrowing limits associated with collateral constraints, they ensure that the negative consequences of a temporary tightening in financial markets are not quickly repaired. In the presence of persistent heterogeneity in both capital and total factor productivity, the effects of a financial shock can be amplified and propagated through large and long-lived disruptions to the distribution of capital that, in turn, imply large and persistent reductions in aggregate total factor productivity. Similarly, the consequences of a negative real shock can be exacerbated and prolonged in the presence of real and financial frictions. This paper seeks to measure the strength of these effects in a calibrated DSGE setting.

Suggested Citation

  • Julia K. Thomas & Aubhik Khan, 2009. "Collateral constraints, capital specificity and the distribution of production: the role of real and financial frictions in aggregate fluctuations," 2009 Meeting Papers 1133, Society for Economic Dynamics.
  • Handle: RePEc:red:sed009:1133
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    File URL: https://economicdynamics.org/meetpapers/2009/paper_1133.pdf
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    References listed on IDEAS

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    1. Francisco J. Buera & Yongseok Shin, 2013. "Financial Frictions and the Persistence of History: A Quantitative Exploration," Journal of Political Economy, University of Chicago Press, vol. 121(2), pages 221-272.
    2. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    3. Diego A. Comin & Thomas Philippon, 2006. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Chapters,in: NBER Macroeconomics Annual 2005, Volume 20, pages 167-228 National Bureau of Economic Research, Inc.
    4. Caggese, Andrea, 2007. "Financing constraints, irreversibility, and investment dynamics," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2102-2130, October.
    5. Khan, Aubhik & Thomas, Julia K., 2003. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 331-360, March.
    6. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
    7. Aubhik Khan & Julia K. Thomas, 2008. "Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics," Econometrica, Econometric Society, pages 395-436.
    8. Diego Restuccia & Richard Rogerson, 2008. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 707-720, October.
    9. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
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