Financial Stress and the Debt Structure

Abstract

This paper identifies shocks to credit conditions based on aggregate firms’ debt composition. I develop a model where firms fund production with bonds and loans. Only financial shocks imply opposite movements in the two types of debt as firms adjust their debt composition to new credit conditions. I use this result to inform a sign‑restriction VAR and identify the sources of US business cycles. Financial shocks account for a third of output fluctuations. I construct an index of financial stress to test the identification strategy.