Research

Job Market Paper

• Firm Debt Relief in Financial Downturn: link (paper), link (slides) 

Abstract: Can targeting firm debt relief improve stabilization policy in a financial crisis? I study the stabilization effects of firm-specific debt relief in a financial crisis. I construct a DSGE model of heterogeneous firms, calibrated to U.S. data, including the unconditional size distribution of firms. Firms face persistent idiosyncratic risk and financial frictions that give rise to an endogenous distribution over capital, debt, and productivity, while leading to capital misallocation and life-cycle effects. I model financial frictions by assuming collateralized borrowing. A shock to firms’ access to credit exacerbates misallocation, leading to a crisis similar to that of the Great Recession. Importantly, as the effects of the shock are not proportional across the distribution, the model is solved non-linearly and equilibrium decision rules are being resolved for all firms at each date. This disproportional misallocation creates a role for targeted policy: the government borrows on behalf of financially constrained firms and provides debt relief, allowing firms to invest more. I show that policy targeting firms with the highest level of excess return to investment in a crisis reduces the drop in output by over 26 percent. To consider policy targets with historical precedent, I study firm size and age as alternative targets. The model is well-suited for this, as it produces an age-size distribution of firms matching U.S. data; this distribution is untargeted in the calibration. To my knowledge, this work is the first of its kind to be able to produce such size, and age-size distributions matching U.S. data. Though there is more investment inefficiency to correct among small firms, I find policy targeting medium size firms outperforms other size and age targets. Medium size firms have a larger efficient size than small firms; they continue to grow more, creating a more persistent effect of debt relief policy.