International Economic Review, Volume 62(1), February 2021, Pages 405-460
We document a strong empirical relationship between higher income inequality and stronger recessive impacts of fiscal consolidation episodes across time and space. To explain this finding, we develop a life-cycle economy with uninsurable income risk. We calibrate our model to match key characteristics of several European economies, including inequality and fiscal structures, and study the effects of fiscal consolidation programs. In our model, higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. These agents have less elastic labor supply responses to fiscal consolidations, which explain the correlation with inequality in the data.
3rd Revision requested at Journal of Public Economics
We argue that the fiscal multiplier of government purchases is increasing in the spending shock, in contrast to what is assumed in most of the literature. The fiscal multiplier is largest for large positive government spending shocks and smallest for large contractions in government spending. We empirically document this fact using aggregate U.S. data. We find that a neoclassical, life-cycle, incomplete markets model calibrated to match key features of the US economy can explain this empirical finding. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the size of the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed (albeit through different mechanisms). We find evidence of our mechanism in micro data for the US.
Submitted - Previous circulated as "Aggregate Implications of Corporate Lending by Nonfinancial Firms"
This paper explores the impact of risky asset holdings by U.S. nonfinancial firms. From the early 1990s to 2017, the share of risky securities surged from 28% to over 40% of firms’ financial assets. Using a business-cycle heterogeneous firms model, I show that declining real interest rates since the 1980s increased the risk premium, driving the increase in risky asset holdings. The model predicts that firms with higher exposure to risky assets experience an investment decline up to 50% more pronounced during large shocks, empirically validated by analyzing the Great Financial Crisis.
Submitted - Previous circulated as "Financial factors, firm size and firm potential"
Using a unique dataset covering the universe of Portuguese firms and their credit situation we show that financially constrained firms are found across the entire firm size distribution, even in the top 1%. Incorporating a richer, empirically supported, productivity process into a standard heterogeneous firms model generates a joint distribution of size and credit constraints in line with the data. The presence of large constrained firms in the economy, together with their elevated capital share, explains about 66% of the response of output to a financial shock. We conclude by providing micro-evidence in support of the model mechanism.
This paper studies the macroeconomic implications of corporate cash holdings over the business cycle. We develop a heterogeneous firm business cycle model in which firms accumulate cash for precautionary reasons. Firm-level cash accumulation is highly nonlinear due to a satiation point. The nonlinearity survives aggregation, leading to a state-dependent response of aggregate allocations to TFP shocks. In periods of high cash holdings, firms can smooth dividend payouts, thereby dampening the response of aggregate consumption to adverse TFP shocks. Despite this stabilizing role, we show that the decentralized equilibrium level of cash holdings is inefficiently high due to a negative cash externality. We conclude by providing micro-level empirical evidence in support of the model’s key mechanisms.
Financial frictions are a prominent feature of theories for a broad range of macroeconomic phenomena. Using a novel loan-level dataset, we evaluate whether these theories are broadly consistent with observed interest rates. We find that there is a lot of dispersion in rates paid by firms, even on observationally equivalent loans, and risk---the dominant theory for dispersion---can account for less than 15% of it. Alternative theories for dispersion, based on banks and bank-firm relationships, also have quantitatively little explanatory power. Instead the data dictates the major source of variation is factors that are idiosyncratic to firms, persistent, and not closely connected to economic size or performance. We provide a search-based theory of firm financing that can rationalize these facts.
A simple model predicts that firms with lumpy investment profiles face elevated external finance premia, leading to a reduced propensity to adjust. This creates lumpy investment spirals - firms failing to adjust also face higher premia in the future, decreasing their propensity to invest tomorrow. Using Compustat data we show that these predictions are consistent with observed investment lumpiness and risk premium patterns. Finally, we analyse how the presence of lumpy investment spirals affects capital misallocation and aggregate shock sensitivity in a heterogeneous firms model with financial frictions.