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Essays on Business Cycles with Credit Shocks

Jo, In Hwan
http://rave.ohiolink.edu/etdc/view?acc_num=osu1429292314

Abstract Details

2015, Doctor of Philosophy, Ohio State University, Economics.
A recent but growing literature in macroeconomics works to reconcile microeconomic data with the micro-level predictions of dynamic stochastic equilibrium models in an effort to improve the aggregate performance of macroeconomic models. My dissertation follows in this new tradition. It also contributes to a recently revitalized literature attempting to understand the links between financial markets and real economic activity. The essays discussed below examine how real and financial shocks affect the distribution of production in an economy, and how that distribution in turn influences aggregate quantity variables. The models I explore involve rich, time-varying distributions of firms differing in their capital stocks, debt, and productivities. In the first chapter, "Firm Size and Business Cycles with Credit Shocks," I highlight the importance of empirically consistent firm-level heterogeneity in shaping aggregate dynamics. A large empirical literature documents that the firm size distribution is highly-skewed, a finding that business cycle studies typically ignore. I quantitatively investigate the macroeconomic implications of a realistic size distribution in an economy with real and financial shocks. Specifically, I build a tractable model including heterogeneous firms in which each firm faces persistent shocks to both individual and aggregate productivity. Firms choose employment, investment and debt, and these decisions are made in a setting with forward-looking collateral constraints that limit loan sizes as a function of firms’ chosen capital stocks. In addition to reproducing the empirical firm size distribution, I jointly estimate the parameters governing aggregate productivity and financial shocks using a simulated method of moments approach. The estimated shock processes drive plausible business cycle dynamics in my model and allow me to isolate the importance of financial shocks in driving business cycles. A central finding of my study is that the aggregate elasticity of response to a financial shock is underestimated when the size distribution of firms fails to reproduce the degree of skewness observed in firm-level data. In other words, existing studies under-predict the severity of financially-generated recessions and so must rely on very large financial shocks to explain recessions like the 2007 U.S. recession. Furthermore, I find that including a realistic firm size distribution in my model helps to explain the slow employment recovery following a financial recession, a second puzzle of particular interest since the 2007 recession. By contrast, my model predicts that the aggregate response following a common productivity shock is largely unaffected by the underlying size distribution of firms. Thus, existing models are equally successful in explaining business cycles arising from real shocks. A financial shock in my model produces dissimilar responses across firms of different sizes and ages, whereas a productivity shock does not. In particular, financial shocks have disproportionate negative impacts on small firms in my model, which is consistent with the relative employment declines among such firms over the last U.S. recession. In the second chapter, "Production Heterogeneity with Borrowing Constraints and Working Capital", I consider the extent to which the weak labor market recovery seen following the 2007 recession may be explained by a credit shock. A notable aspect of this recession has been the persistent widening of the aggregate labor wedge, the gap between the marginal product of labor and the marginal rate of substitution of leisure for consumption. I explore this using an equilibrium model with frictional hiring decisions by heterogeneous firms. In my model, external financing for a firm is constrained by both a working capital requirement and a collateralized borrowing limit. As a result, each firm’s credit is affected by both its employment and collateral, and some choose to hire less than the statically optimal labor input in order to obtain more external funds for investment. Following a sudden tightening of credit in my model economy, this firm-level labor demand distortion is exacerbated, driving an increased aggregate labor wedge. The greater misallocation of labor that this reflects itself amplifies the decline in aggregate employment and production and, because reallocation following the credit shock is not immediate, it delays and protracts the economic recovery.
Aubhik Khan (Advisor)
Julia Thomas (Committee Member)
Lu Zhang (Committee Member)
116 p.
Economics

Recommended Citations

Citations

  • Jo, I. H. (2015). Essays on Business Cycles with Credit Shocks [Doctoral dissertation, Ohio State University]. OhioLINK Electronic Theses and Dissertations Center. http://rave.ohiolink.edu/etdc/view?acc_num=osu1429292314

    APA Style (7th edition)

  • Jo, In Hwan. Essays on Business Cycles with Credit Shocks. 2015. Ohio State University, Doctoral dissertation. OhioLINK Electronic Theses and Dissertations Center, http://rave.ohiolink.edu/etdc/view?acc_num=osu1429292314.

    MLA Style (8th edition)

  • Jo, In Hwan. "Essays on Business Cycles with Credit Shocks." Doctoral dissertation, Ohio State University, 2015. http://rave.ohiolink.edu/etdc/view?acc_num=osu1429292314

    Chicago Manual of Style (17th edition)

osu1429292314
482
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This open access ETD is published by The Ohio State University and OhioLINK.