We study the effects of credit shocks in a model with heterogeneous entrepreneurs, financing constraints, and a realistic firm-size distribution. As entrepreneurial firms can grow only slowly and rely heavily on retained earnings to expand the size of their business, we show that, by reducing entrepreneurial firm size and earnings, negative shocks have a very persistent effect on real activity. In determining the speed of recovery from an adverse economic shock, the most important factor is the extent to which the shock erodes entrepreneurial wealth.
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We are grateful to the editors, an anonymous referee, Matthias Doepke, Igor Livshits, Guido Lorenzoni, Nikolai Roussanov, Ali Shourideh, and many seminars participants for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Chicago, the Board of Governors, or the Federal Reserve System. Marco Bassetto and Mariacristina De Nardi acknowledge financial support from the ESRC Grant # ES/L500343/1 through the Centre for Macroeconomics.
© 2014 The Authors.
- Borrowing constraints
- Credit allocation
- Credit crunches
- Wealth inequality