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Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity

  • Julia K. Thomas

    (Ohio State University)

  • Aubhik Khan

    (Ohio State University)

In sum, we find that an unanticipated tightening in borrowing conditions on its own can generate a large recession that is far more persistent than the financial shock itself. Because it causes long-lived disruption in the distribution of capital, and thus production, an episode of tight credit leaves behind long, anemic recoveries in total output and consumption. At the heart of these slow returns is the gradual repair of measured productivity and aggregate capital. For this reason, the recovery following a temporary financial crisis is far more gradual than that after a similarly temporary shock directly reducing aggregate TFP. A second aspect distinguishing the episode following a financial shock is the fact that household consumption spending plays no useful role in the economic recovery; instead, recovery is driven by sharp rises in the labor input that ultimately generate the rises in investment necessary to rebuild the aggregate capital stock.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 801.

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Date of creation: 2010
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Handle: RePEc:red:sed010:801
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