Aggregate Consequences of Dynamic Credit Relationships

56 Pages Posted: 26 Nov 2016 Last revised: 21 Oct 2018

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: October 24, 2017


I investigate the aggregate consequences of canonical financial frictions in the supply of credit to firms: private information and limited enforcement. I propose a general equilibrium model in which entrepreneurs finance their firm through a long-term contract with a financial intermediary. The contract is inefficient because firm cash flow is costly to monitor and borrowers that repudiate cannot be excluded from capital markets. By investing in enforcement capacity, an intermediary can delay debt repayment and maintain incentive compatibility. Reforms that seek to decrease the cost of monitoring or enforcing contracts, or both, affect firm dynamics and can generate complementaries. Estimating the model with data on Colombian manufacturing firms in the 1980s and 1990s, I find that financial frictions are responsible for a significant aggregate output loss. Most of this distortion can be attributed to private information. Reforms that only reduce private information create significant economic growth and welfare gains, while those that only improve enforcement do not. There are significant complementarities between different types of reforms, as moral hazard is less significant when contracts are more enforceable.

Keywords: Private Information, Limited Enforcement, Dynamic Financial Contracting, Financial Development, Firm Dynamics, Colombia

JEL Classification: E22, D82, G32, L14, O11, O54

Suggested Citation

Verani, Stephane, Aggregate Consequences of Dynamic Credit Relationships (October 24, 2017). Available at SSRN: or

Stephane Verani (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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


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