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Default Risk and Aggregate Fluctuations in an Economy with Production Heterogeneity

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  • Julia K. Thomas

    (Ohio State University)

  • Aubhik Khan

    (Ohio State University)

Abstract

We study business cycle driven by exogenous changes in total factor productivity and credit shocks. The latter involve changes to the fraction of assets that lenders may seize in the event of default. Following changes in aggregate total factor productivity, we find that our non-contingent loan contracts drive countercyclical default risk. When firms face fixed costs of operation, this leads to a worsening of the allocation of capital in recessions that amplifies the effects of technology shocks. Following credit shocks, we see a reduction in economic activity that is qualitatively different from that following a technology shock. The response in investment is more serve, while the responses in consumption, employment and output are more gradual. In contrast to existing analysis of credit shocks with exogenous collateral constraints, our environment does not predict a slow recovery when borrowing conditions return to normal.

Suggested Citation

  • Julia K. Thomas & Aubhik Khan, 2011. "Default Risk and Aggregate Fluctuations in an Economy with Production Heterogeneity," 2011 Meeting Papers 1333, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:1333
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    3. In Hwan Jo & Tatsuro Senga, 2016. "Firm Dynamics, Misallocation and Targeted Policies," Working Papers 809, Queen Mary University of London, School of Economics and Finance.
    4. Venky Venkateswaran & Laura Veldkamp & Julian Kozlowski, 2015. "The Tail that Wags the Economy: Belief-Driven Business Cycles and Persistent Stagnation," 2015 Meeting Papers 800, Society for Economic Dynamics.
    5. Marios Karabarbounis & Patrick Macnamara, 2021. "Misallocation and Financial Frictions: the Role of Long-Term Financing," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 40, pages 44-63, April.
    6. Salem Abo‐Zaid & Anastasia Zervou, 2020. "Financing of Firms, Labor Reallocation, and the Distributional Role of Monetary Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 122(2), pages 790-823, April.
    7. Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2020. "The Tail That Wags the Economy: Beliefs and Persistent Stagnation," Journal of Political Economy, University of Chicago Press, vol. 128(8), pages 2839-2879.
    8. Gete, Pedro, 2018. "Lending standards and macroeconomic dynamics," Working Paper Series 2207, European Central Bank.
    9. Dean Corbae & Pablo D'Erasmo, 2017. "Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics," NBER Working Papers 23515, National Bureau of Economic Research, Inc.
    10. In Hwan Jo & Tatsuro Senga, 2019. "Aggregate Consequences of Credit Subsidy Policies: Firm Dynamics and Misallocation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 68-93, April.
    11. Julia Thomas & Berardino Palazzo & Aubhik Khan & Gian Luca Clementi, 2014. "Entry, Exit and the Shape of Aggregate Fluctuations in a General Equilibrium Model with Capital Heterogeneity," 2014 Meeting Papers 1344, Society for Economic Dynamics.
    12. Joao Ayres & Gajendran Raveendranathan, 2018. "The Firm Dynamics of Business Cycles," Department of Economics Working Papers 2018-16, McMaster University.
    13. António R. Antunes & Tiago Cavalcanti & Caterina Mendicino & Marcel Peruffo & Anne Villamil, 2019. "Tighter Credit and Consumer Bankruptcy Insurance," Working Papers w201921, Banco de Portugal, Economics and Research Department.
    14. Silva, Mario Rafael, 2019. "Corporate finance, monetary policy, and aggregate demand," Journal of Economic Dynamics and Control, Elsevier, vol. 102(C), pages 1-28.
    15. Pablo Ottonello & Thomas Winberry, 2020. "Financial Heterogeneity and the Investment Channel of Monetary Policy," Econometrica, Econometric Society, vol. 88(6), pages 2473-2502, November.
    16. Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2019. "The Tail That Keeps the Riskless Rate Low," NBER Macroeconomics Annual, University of Chicago Press, vol. 33(1), pages 253-283.
    17. Fernando Leibovici & David Wiczer, 2019. "Firm-level credit ratings and default in the Great Recession: Theory and evidence," 2019 Meeting Papers 1389, Society for Economic Dynamics.
    18. In Hwan Jo & Tatsuro Senga, 2019. "Aggregate Consequences of Credit Subsidy Policies: Firm Dynamics and Misallocation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 68-93, April.
    19. Simon Mongey & Gianluca Violante & Alessandro Gavazza, 2015. "What Shifts the Beveridge Curve? Recruiting Intensity and Financial Shocks," 2015 Meeting Papers 1079, Society for Economic Dynamics.
    20. Cui, Wei & Kaas, Leo, 2021. "Default cycles," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 377-394.
    21. Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2020. "Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19," NBER Working Papers 27439, National Bureau of Economic Research, Inc.
    22. Ia Vardishvili, 2020. "Entry Decision, the Option to Delay Entry, and Business Cycles," Auburn Economics Working Paper Series auwp2020-07, Department of Economics, Auburn University.
    23. Xiaodan Gao & Shaofeng Xu, 2018. "The Role of Corporate Saving over the Business Cycle: Shock Absorber or Amplifier?," Staff Working Papers 18-59, Bank of Canada.
    24. Julia Thomas & Aubhik Khan, 2012. "Uncertainty Shocks in an Economy with Collateral Constraints," 2012 Meeting Papers 1075, Society for Economic Dynamics.

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