ABSTRACTS
“Are There Any Spillovers between Household and Firm Financing Frictions? A Dynamic General Equilibrium Analysis” [Job Market Paper]
Economic commentators frequently imply the existence of positive spillovers between the financing frictions affecting households and firms, suggesting another way in which credit constraints may amplify aggregate shocks and increase the persistence of aggregate fluctuations. To examine this possibility, I develop a new model that incorporates both firm and household external finance spreads, while improving in several dimensions on existing frameworks. Contrary to a common intuition, the baseline Real Business Cycle model with credit constraints produces small negative spillovers between the costs of external financing for firms and households. A key factor in this result is the income effect of changes in the external finance premium on borrower labour supply. The reduction in households’ cost of borrowing in a boom decreases labour supply, increases the risk free interest rate and crowds out investment, raising borrowing costs for financially constrained firms.
“Bank Capital, Housing and Credit Constraints” (with Jing Yang)
We integrate household financing frictions with bank financing frictions and housing price fluctuations in a dynamic stochastic general equilibrium model. We use a two-sided debt contract framework in which the bank cannot fully diversify shocks to its borrowers to study the link between household and bank sectors' default risks. The cyclical behaviour of the banks’ external finance premium is determined by two main factors. Booms improve the financial health of the banks' borrowers which tends to reduce the cost of bank funding. At the same time, consumption smoothing by savers and borrowers makes the proportion of costly external financing in the banks' balance sheet more procyclical. As a result of these opposing effects, the model matches procyclical profits and leverage in the financial sector, as observed in the data. Nevertheless the banking frictions in the model have an insignificant impact on the main macroeconomic aggregates such as output, consumption and investment.
“Banks as Better Monitors and Firms' Financing Choices in Dynamic General Equilibrium”
This paper builds a dynamic general equilibrium model that emphasizes banks' comparative advantage in monitoring financial distress in order to explain firms' choice between bank loans and market debt. Banks can deal with financial distress more cheaply than bond holders, but this requires a higher initial expenditure proportional to the loan size. In contrast, bond issues may involve a small fixed cost. Entrepreneurs' choice of bank or bond financing depends on their net worth. The steady state of the model can explain why smaller firms tend to use more bank financing and why bank financing is more prevalent in Europe than in the US. A higher fixed cost of issuing market debt is a key factor in replicating the higher use of bank financing relative to market debt in Europe. Finally, we find that for plausible calibrations one can predict aggregate quantities just as well using a model with only one type of loan with costs of financial distress that are an average of the costs for bank loans and market debt.