Aggregate Consequences of Dynamic Credit Relationships

61 Pages Posted: 28 Jan 2015 Last revised: 8 Sep 2015

See all articles by Stephane Verani

Stephane Verani

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: August 14, 2015

Abstract

Which financial frictions matter in the aggregate? This paper presents a general equilibrium model in which entrepreneurs finance a firm with a long-term contract. The contract is constrained efficient because firm revenue is costly to monitor and entrepreneurs may default. The cost of monitoring firms and the entrepreneurs' outside options determine the significance of moral hazard relative to limited enforcement for financial contracting. Calibrating the model to the U.S. economy, I find that the relative welfare loss from financial frictions is about 5 percent in terms of aggregate consumption with moral hazard, while it is 1 percent with limited enforcement. Reforms designed to strengthen contract enforcement increase aggregate consumption in the short-run, but their long-run effects are modest when monitoring costs are high. Weak contract enforcement contribute to aggregate fluctuations by amplifying the effect of aggregate technological shocks, but moral hazard does not.

Keywords: private information; limited enforcement; financial contracting; financial development; firm dynamics

JEL Classification: E32, D82, G32, L14

Suggested Citation

Verani, Stephane, Aggregate Consequences of Dynamic Credit Relationships (August 14, 2015). FEDS Working Paper No. 2015-063, Available at SSRN: https://ssrn.com/abstract=2556285 or http://dx.doi.org/10.2139/ssrn.2556285

Stephane Verani (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/stephane-verani.htm

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
23
Abstract Views
448
PlumX Metrics