Publication
Firm Size and Business Cycles with Credit Shocks
forthcoming at International Economic Review, Oct. 2024 (Paper) (Appendix)
I study the macroeconomic implications of firm heterogeneity in the presence of financial frictions. I build a business cycle model in which firm size is jointly determined by idiosyncratic productivity and collateral constraints. I estimate skewed idiosyncratic shocks and align the model with the evidence on firm size, leverage, and investment moments. The extent of resource misallocation is driven by a small number of highly productive but financially constrained firms. A credit shock severely affects such firms, further constraining their ability to borrow. This generates a large and persistent economic downturn that is comparable to the Great Recession.
Aggregate Consequences of Credit Subsidy Policies: Firm Dynamics and Misallocation
with Tatsuro Senga, Review of Economic Dynamics, Apr. 2019 (Paper) (Appendix)
Government policies that attempt to alleviate credit constraints faced by small and young firms are widely adopted across countries. We study the aggregate impact of such targeted credit subsidies in a heterogeneous firm model with collateral constraints and endogenous entry and exit. A defining feature of our model is a non-Gaussian process of firm-level productivity, which allows us to capture the skewed firm size distribution seen in the Business Dynamics Statistics (BDS). We compare the welfare and aggregate productivity implications of our non-Gaussian process to those of a standard AR(1) process. While credit subsidies resolve misallocation of resources and enhance aggregate productivity, increased factor prices, in equilibrium, reduce the number of firms in production, which in turn depresses aggregate productivity. We show that the latter indirect general equilibrium effects dominate the former direct productivity gains in a model with the standard AR(1) process, as compared to our non-Gaussian process, under which both welfare and aggregate productivity increase by subsidy policies.
Working Paper
Firm Debt and Default over the Pandemic and Recovery
with Aubhik Khan, Tatsuro Senga, and Julia Thomas, Oct. 2024 (Paper)
We study aggregate dynamics in an economy with production heterogeneity, financial frictions, and an infectious disease. Firms face persistent shocks to individual productivity and finance investment using non-contingent debt. Default risk rises with leverage and leads to costly borrowing for firms with insufficient wealth. Infection across households brings differences in health and employment status. Healthy individuals may work but experience a higher risk of infection which increases with the number of ill individuals.
We show that a persistent recession follows an outbreak of a pandemic. Households reduce labor supply in an effort to restrain contagion, taking into account the evolution of health distribution. Firms are adversely affected by lower earnings, its extent varying with financial status. Highly leveraged borrowers are more likely to default, exit rises, and the number of producers falls. Continuing firms find it harder to finance investment, and entry is discouraged. The dispersion of resource allocation rises and aggregate productivity falls endogenously. Business subsidies mitigate losses in allocative efficiency at a cost of generating a larger recession.
The economic recovery is gradual and prolonged as the pandemic ends. Entry rises and the number of firms begins to return to its long-run level. Financial frictions, however, restrict immediate growth of young firms with higher leverage and default risk. Instead, capital is allocated to relatively larger and less productive incumbents, slowing down improvements in aggregate productivity.
Idiosyncratic Risk, Long-term Debt, and Aggregate Productivity
with Aubhik Khan and Soyoung Lee, Feb. 2023 (draft available upon request)
We study the effect of costly external finance on the allocation of resources and economic development in a general equilibrium model where entrepreneurs vary in their total factor productivity, financial assets, and debt. Short-term loans used to finance production are constrained by an entrepreneur's collateral. Our framework introduces a novel ingredient: long-term defaultable debt. The amount of collateral available for within-period credit is commonly used as a proxy for financial frictions. Our analysis allows entrepreneurs to take on risky, illiquid loans that help mitigate the impact of their collateral constraint in their production. In this environment, we quantitatively assess how the costs of long-term borrowing and consumption smoothing motives jointly affect aggregate output and productivity in economies with less developed financial markets. Specifically, risky, illiquid debt increases the consumption volatility of producers already facing uninsurable productivity risk. This leads to a reduction in the production share of poor, highly productive entrepreneurs and increases misallocation when compared to a model without risky, long-term debt. Higher costs of borrowing, or less liquid loans, both deter investment by productive but poor entrepreneurs and reduce the share of the population that engages in entrepreneurship. We study a variety of different costs of borrowing in our framework. One important ingredient is random access to external finance. In periods without access, borrowers cannot actively adjust their debt but must continue with existing principal payments or default. Default is costly as it leads to a loss of assets. When the expected period without access to the debt markets rises from 4 to 20 years, entry falls 50 percent, and measured total factor productivity decreases by 15 percent.
Work in Progress
A Practical Approach to Dynamic Programming with Two Continuous Endogenous States
with Aubhik Khan
Government Spending and Financial Reform in Developing Economies
with Yushin Bu