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Fluctuations in uncertainty, efficient borrowing constraints and firm dynamics


  • Sebastian Dyrda

    (University of Minnesota)


In this paper, I quantify the importance of microeconomic uncertainty shocks for the firm dynamics over the business cycle in an economy with frictional financial markets. To begin, I document facts on asymmetric response across age and size groups of firms in the U.S. to the changes in aggregate economic conditions. I argue that age rather than size is a relevant margin for the magnitude of employment volatility over the cycle; in particular total employment of young firms varies 2.6 times more relative to the old firms. Then I propose a theory that, contrary to the existing studies, generates endogenously a link between firm's age and size and its ability to obtain financing, and induces an asymmetric response to shocks. A key element of my theory is a financial friction originating from the presence of the firm's private information and long-term, efficient lending contract between a risk averse entrepreneur and financial intermediary, which manifests itself as a borrowing constraint. I argue that, for any given expected return on project, young firms are more constrained in borrowing and they grow out of the constraint as they age up to the optimal, unconstrained size. Next I establish that, for any given age, firm's financing increases in line with the average return on a project. In times of high idiosyncratic uncertainty the financial contract calls for tightening of the borrowing constraint transmitting the initial impulse into a decline in demand for production inputs and further, including general equilibrium effects, into an economic downturn. This mechanism affects disproportionally young firms. Not only are they more constrained in borrowing but also they start smaller due to a reduced level of initial financing. A quantitative version of the model accounts for the fall of the aggregate output, employment and investment, decline of credit to GDP ratio and asymmetric employment dynamics of different groups of firms observed in the US data in recessions.

Suggested Citation

  • Sebastian Dyrda, 2015. "Fluctuations in uncertainty, efficient borrowing constraints and firm dynamics," 2015 Meeting Papers 1243, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1243

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    References listed on IDEAS

    1. Julio Dávila & Jay H. Hong & Per Krusell & José‐Víctor Ríos‐Rull, 2012. "Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks," Econometrica, Econometric Society, vol. 80(6), pages 2431-2467, November.
    2. Zetlin-Jones, Ariel & Shourideh, Ali, 2017. "External financing and the role of financial frictions over the business cycle: Measurement and theory," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 1-15.
    3. Peter M. DeMarzo & Michael J. Fishman, 2007. "Agency and Optimal Investment Dynamics," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 151-188, January.
    4. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2010. "The Macroeconomic Implications of Rising Wage Inequality in the United States," Journal of Political Economy, University of Chicago Press, vol. 118(4), pages 681-722, August.
    5. Teresa C Fort & John Haltiwanger & Ron S Jarmin & Javier Miranda, 2013. "How Firms Respond to Business Cycles: The Role of Firm Age and Firm Size," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 61(3), pages 520-559, August.
    6. Stephane Verani, 2018. "Aggregate Consequences of Dynamic Credit Relationships," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 44-67, July.
    7. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
    8. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March.
    9. Christian Bayer & Ruediger Bachmann, 2009. "The Cross-section of Firms over the Business Cycle: New Facts and a DSGE Exploration," 2009 Meeting Papers 866, Society for Economic Dynamics.
    10. Quadrini, Vincenzo, 2004. "Investment and liquidation in renegotiation-proof contracts with moral hazard," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 713-751, May.
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    Cited by:

    1. Stephane Verani, 2018. "Aggregate Consequences of Dynamic Credit Relationships," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 44-67, July.
    2. Smith, Anthony Jr. & Wang, Cheng, 2006. "Dynamic credit relationships in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 847-877, May.
    3. Alex Clymo, 2018. "Firm Dynamics at the Zero Lower Bound," 2018 Meeting Papers 912, Society for Economic Dynamics.
    4. Joao Ayres & Gajendran Raveendranathan, 2018. "The Firm Dynamics of Business Cycles," Department of Economics Working Papers 2018-16, McMaster University.
    5. Stephane Verani, 2018. "Aggregate Consequences of Dynamic Credit Relationships," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 44-67, July.

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