Business Cycle Effects of Credit and Technology Shocks in a DSGE Model with Firm Defaults

49 Pages Posted: 17 Oct 2011

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

TengTeng Xu

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: October 17, 2011

Abstract

This paper proposes a theoretical framework to analyze the impacts of credit and technology shocks on business cycle dynamics, where firms rely on banks and households for capital financing. Firms are identical ex ante but differ ex post due to different realizations of firm specific technology shocks, possibly leading to default by some firms. The paper advances a new modelling approach for the analysis of financial intermediation and firm defaults that takes account of the financial implications of such defaults for both households and banks. Results from a calibrated version of the model highlights the role of financial institutions in the transmission of credit and technology shocks to the real economy. A positive credit shock, defined as a rise in the loan to deposit ratio, increases output, consumption, hours and productivity, and reduces the spread between loan and deposit rates. The effects of the credit shock tend to be highly persistent even without price rigidities and habit persistence in consumption behavior.

Keywords: bank credit, financial intermediation, firm heterogeneity and defaults, interest rate spread, real financial linkages

JEL Classification: E320, E440, G210

Suggested Citation

Pesaran, M. Hashem and Xu, TengTeng, Business Cycle Effects of Credit and Technology Shocks in a DSGE Model with Firm Defaults (October 17, 2011). CESifo Working Paper Series No. 3609, Available at SSRN: https://ssrn.com/abstract=1945080

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

TengTeng Xu

affiliation not provided to SSRN ( email )

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