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

  • Julia K. Thomas

    (The Ohio State University and NBER)

  • Aubhik Khan

    (The Ohio State University)

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.

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File URL: https://economicdynamics.org/meetpapers/2009/paper_1133.pdf
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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1133.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1133
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Diego Restuccia & Richard Rogerson, 2007. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," NBER Working Papers 13018, National Bureau of Economic Research, Inc.
  2. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  3. 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.
  4. Aubhik Khan & Julia Thomas, 2007. "Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics," NBER Working Papers 12845, National Bureau of Economic Research, Inc.
  5. Andrea Caggese, 2003. "Financing constraints, irreversibility, and investment dynamics," LSE Research Online Documents on Economics 24828, London School of Economics and Political Science, LSE Library.
  6. Diego Comin & Thomas Philippon, 2005. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Working Papers 11388, National Bureau of Economic Research, Inc.
  7. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  8. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
  9. 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.
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