Credit Market Frictions Research Articles

Merchants of Death: The Effect of Credit Supply Shocks on Hospital Outcomes

This study examines the link between credit supply and hospital health outcomes. We use bank stress tests as exogenous shocks to credit access for hospitals that have lending relationships with tested banks. We find that affected hospitals shift their operations to increase resource utilization following a negative credit shock but reduce the quality of their care to patients across a variety of measures, including a significant increase in risk-adjusted readmission and mortality rates. The results indicate that access to credit can affect the quality of health care hospitals deliver, pointing to important spillover effects of credit market frictions on health outcomes. (JEL G21, G32, I11, I18)

Credit Market Frictions and the Linkage Between Dispersion and Macro Uncertainty

Cross-sectional dispersion and macro uncertainty (volatility of aggregate economic variables) are conceptually distinct. However, empirically, they both comove and are countercyclical. This paper builds a general equilibrium model and demonstrates that credit market frictions allow cross-sectional dispersion to drive time-varying macro uncertainty endogenously. In the model, as firm-level productivity becomes more dispersed, more firms are pushed to the left tail of the productivity distribution, resulting in more defaults and a depletion in aggregate net worth. This mechanism generates countercyclical leverage and aggregate volatility. The model implies that the government can inject equity in economic downturns to stabilize aggregate volatility. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00166 .

Sukūk development and income inequality

This paper investigates the link between sukūk development and income inequality by scrutinizing twenty-two countries’ data from 1995 to 2019. We employ the two-stage Fractional Regression Model to illustrate that sukūk issuance is associated with increased income disparity. This result is attributed to the sukūk design ignoring credit market frictions. This rationalizes the sukūk-inequality nexus in light of the ethical objectives of Islamic law. We argue that reinforcing property rights by mitigating the ill effects of excessive risk-taking (i.e., gharar) and endemic agency costs of debt (i.e., ribā) in our ethical framework can improve sukūk’s role in socio-economic development.

Intergenerational transfers: Public education and pensions with endogenous fertility

We consider an overlapping generations economy, where parents are altruistic towards their children, and children provide old-age support to parents. We show that when the education loan market is imperfect, an education subsidy targeted towards achieving the complete-market level of education distorts fertility decisions. However, augmenting the education policy with pension support in the old-age can restore both education and fertility to complete-market level. This highlights that an Education-Pension package is more potent than perceived by the existing literature – it not only replaces the missing credit market but also corrects for fertility distortions. Our results also hold when state intervention in education is justified due to human-capital externality, instead of credit market frictions.

The Impact of Macro-Economic Environment on Probability of Non-Performing Loans in Financial Institutions

The rise in mortgage defaults in the banking industry highlights the connections between financial and macroeconomic shocks as well as the risk of financial instability created by credit market friction. The percentage of non-performing loans in the banking industry is assessed in this study in connection to the effects of the global economy. In order to do a regression analysis, three American banks are chosen, and the variables GDP growth, unemployment rate, real interest rate, and CPI are taken into account. The study found a significant correlation between the percentage of non-performing loans and the unemployment rate (NPL). The results of Wells Fargo indicates that there is no obvious link between GDP and NPL. There is an association between GDP expansion and the percentage of non-performing loans for Citi Bank and Bank of America. Real interest rates and NPL do not significantly affect one another. Therefore, even though some factors might not affect such probabilities, changes in the economic climate may have an impact on banks' likelihood of non-performing loans.

Credit Market Frictions and Coessentiality of Money and Credit

AbstractWe explore how credit market frictions matter for the coessentiality of money and credit. Limited commitment calls for credit limits that are tailored according to borrowers' productivity. Under an adverse selection problem caused by asymmetric information, however, lenders impose the credit limit of the low‐productivity borrower onto the high‐productivity borrower. If productivities differ sufficiently between borrowers, the high‐productivity borrower is credit‐constrained and is willing to hold money to compensate for the deficiency of their credit limit, whereas the low‐productivity borrower is not. This implies the coessentiality of money and credit in the sense that their simultaneous use improves welfare.

Small Business Lending in Financial Crises: The Role of Government-Guaranteed Loans

Abstract This paper examines whether the presence of government-guaranteed lenders helps alleviate small business financial constraints during financial crises. The results indicate that during the 2007–09 financial crisis, areas with a greater share of Small Business Administration 7(a) lenders experienced: (1) a 2.2% increase in small business loan volume, (2) a 3.7% increase in small firm employment and 3.5% increase in establishments, and (3) lower loan default rates. Bank–county–year analysis suggests that SBA banks increase their share of lending when they are capital-constrained, and when local median income is lower. Instrumental variable analysis utilizing SBA program characteristics confirms the baseline results. The findings suggest that targeted government support can play a beneficial role in the presence of private credit market frictions, especially when bank capital is limited and small business financial constraints are severe.

Optimal Debt Restructuring and Leverage with Credit Market Frictions

Optimal Debt Restructuring and Leverage with Credit Market Frictions

Involuntary entrepreneurship – Evidence from Thai urban data

We structurally estimate a model of occupational choice between wage work and entrepreneurship which allows for ‘involuntary entrepreneurship’ (running a business out of necessity). Involuntary entrepreneurs would earn higher income as workers but cannot access a wage job because of labor market frictions. Using Thai urban household data, we estimate the share of involuntary entrepreneurs as 19% of all businesses in our sample, with robustness runs yielding a range from as low as 7% to as high as 25%, depending on the data stratification and empirical specification. Involuntary entrepreneurs earn significantly lower income (85% less on average) than the rest of the entrepreneurs and are more likely among low-wealth and low-schooling households. Decomposing the estimated effects of the labor and credit market frictions, our results imply 18.7% excess (involuntary) entrepreneurs because of labor market frictions and 0.6% fewer entrepreneurs because of credit frictions, both relative to the unconstrained optimum. Counterfactual policy evaluations show that involuntary entrepreneurship can only be reduced by directly targeting labor market frictions, with attention paid to the equilibrium effect on the market wage.

Merchants of Death: The Effect of Credit Supply Shocks on Hospital Outcomes

This study examines the link between credit supply and hospital health outcomes. Using detailed data on hospitals and the banks that they borrow from, we use bank stress tests as exogenous shocks to credit access for hospitals that have lending relationships with tested banks. We find that affected hospitals shift their operations to enhance their profit margins in response to a negative credit shock, but reduce the quality of their care to patients across a variety of measures. In particular, affected hospitals exhibit significantly lower attentiveness in providing timely and effective treatment and procedures, and are rated substantially lower in patient satisfaction. This decline in care quality is reflected in health outcomes: affected hospitals experience a significant increase in risk-adjusted, unplanned 30-day readmission rates of recently discharged patients and in risk-adjusted 30-day patient mortality rates. Overall, the results indicate that access to credit can affect the quality of healthcare hospitals deliver, pointing to important spillover effects of credit market frictions on health outcomes.

The Collateralizability Premium

Abstract A common prediction of macroeconomic models of credit market frictions is that the tightness of financial constraints is countercyclical. Theory suggests a negative collateralizability premium; that is, capital that can be used as collateral to relax financial constraints insures against aggregate shocks and commands a lower risk compensation compared with noncollateralizable assets. We show that a long-short portfolio constructed using a novel measure of asset collateralizability generates an average excess return of around 8% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the collateralizability premium.

Credit Market Frictions, Business Cycles, and Monetary Policy: The Research Contributions of Charles Carlstrom and Timothy Fuerst

Charles Carlstrom and Timothy Fuerst were prolific and prominent research economists who, until their untimely deaths a few years ago, were long-associated with the Federal Reserve Bank of Cleveland. Their myriad contributions include the incorporation of financial market imperfections into macroeconomic models and the study of optimal monetary policy. We provide an overview of their work and summarize a few key themes from a research conference held in their honor.

Firm Exports, Foreign Ownership, and the Global Financial Crisis

The exceptional export performance of foreign-owned firms is a well-established stylized fact, but the underlying mechanism is not yet fully understood. In this paper, we provide theory and empirical evidence demonstrating that this fact can be explained by ownership differences in access to finance. We develop a theoretical model of international trade featuring firm heterogeneity and credit market frictions in which foreign-owned firms can access foreign capital markets via their multinational parents. The model predicts a financial advantage of foreign ownership for exporting that gains importance as credit conditions deteriorate. To empirically identify this effect, we estimate a triple differences model using rich micro data from Spain that exploits the global financial crisis as an exogenous shock to credit supply. We find that foreign ownership significantly stabilized firm exports when liquidity dried out in the crisis, in particular among small and financially vulnerable firms. (This abstract was borrowed from another version of this item.)

Credit Market Frictions and Coessentiality of Money and Credit

We explore how credit market frictions matter for the coessentiality of money and credit. There are high-productivity and low-productivity borrowers. Limited commitment can yield a one-for-one credit limit in accordance with a borrower's productivity. An adverse selection problem caused by asymmetric information, however, makes lenders impose the credit limit of a low-productivity borrower on a high-productivity borrower. If productivities differ sufficiently between borrowers, a high-productivity borrower is credit-constrained and is willing to hold money to compensate for the deficiency of their credit limit, but a low-productivity borrower is not. This eventually implies the coessentiality of money and credit in the sense that the use of both improves the allocation from a social welfare perspective.

The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data

This paper studies the implications of perceived default risk for aggregate output and productivity. Using a model of credit contracts with moral hazard, we show that a firm's probability of default is a sufficient statistic for capital allocation. The theoretical framework suggests an aggregate measure of the impact of credit market frictions based on firm-level probabilities of default which can be applied using data on firm-level employment and default risk. We obtain direct estimates of firm-level default probabilities using Standard and Poor's PD Model to capture the expectations that lenders were forming based on their historical information sets. We implement the method on the UK, an economy that was strongly exposed to the global financial crisis and where we can match default probabilities to administrative data on the population of 1.5 million firms per year. As expected, we find a strong correlation between default risk and a firm's future performance. We estimate that credit frictions (i) cause an output loss of around 28% per year on average; (ii) are much larger for firms with under 250 employees and (iii) that losses are overwhelmingly due to a lower overall capital stock rather than a misallocation of credit across firms with heterogeneous productivity. Further, we find that these losses accounted for over half of the productivity fall between 2008 and 2009, and persisted for smaller (although not larger) firms.

The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data

This paper studies the implications of perceived default risk for aggregate output and productivity. Using a model of credit contracts with moral hazard, we show that a firm’s probability of default is a sufficient statistic for capital allocation. The theoretical framework suggests an aggregate measure of the impact of credit market frictions based on firm-level probabilities of default which can be applied using data on firm-level employment and default risk. We obtain direct estimates of firm-level default probabilities using Standard and Poor’s PD Model to capture the expectations that lenders were forming based on their historical information sets. We implement the method on the UK, an economy that was strongly exposed to the global financial crisis and where we can match default probabilities to administrative data on the population of 1.5 million firms per year. As expected, we find a strong correlation between default risk and a firm’s future performance. We estimate that credit frictions (i) cause an output loss of around 28% per year on average; (ii) are much larger for firms with under 250 employees and (iii) that losses are overwhelmingly due to a lower overall capital stock rather than a misallocation of credit across firms with heterogeneous productivity. Further, we find that these losses accounted for over half of the productivity fall between 2008 and 2009, and persisted for smaller (although not larger) firms

Nominal GDP Targeting with Heterogeneous Labor Supply

AbstractWe study nominal gross domestic product (GDP) targeting as optimal monetary policy in a model with a credit market friction following Azariadis et al. (2018), henceforth ABSS. We extend the ABSS framework to allow for heterogeneous labor supply. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. We also analyze the incomplete markets equilibrium that exists when the monetary policymaker pursues a suboptimal policy, and show how an extension to more general preferences can limit the ability of the policymaker to provide full insurance to households in this setting.

Credit Market Frictions and the Linkage between Micro and Macro Uncertainty

Micro uncertainty (cross-sectional dispersion) and macro uncertainty (volatility of aggregate economic variables) are conceptually distinct. However, empirically, they comove and are countercyclical. This paper builds a general equilibrium model and demonstrates that credit market frictions allow micro uncertainty to drive time-varying macro uncertainty endogenously. In the model, as dispersion increases, more firms are pushed to the left tail of the productivity distribution, resulting in more defaults and a depletion in aggregate net worth. This mechanism generates countercyclical leverage and aggregate volatility. The model implies that the government can inject equity in economic downturns to stabilize aggregate volatility.

Credit Constraints and Human Capital Policies

We develop a model of voting behavior to show how credit constraints affect a society's demand for government spending on human capital policies, namely, public policies that increase the returns to human capital investments. The main result of the model is that a reduction in credit market frictions can increase the share of government spending on such policies, with a greater increase in poorer societies. We motivate our analysis by providing suggestive cross-country evidence that the composition of government spending is related to credit constraints and provide additional cross-country evidence in support of other predictions of the model.

A Macroeconomic Model with Bond Liquidity

This paper considers a two-country macro model where private bond can serve as financial liquidity. With incomplete markets, higher bond liquidity leads to higher growth from more efficient financing of investment opportunities, but also generates higher instability by increasing equilibrium leverage and worsening the undercapitalized country’s terms of trade. Numerical experiments, based on a parameterized version of the model, show that welfare cost from instability can outweigh gains from higher growth. In particular, bond liquidity reduces welfare in economies with low fundamental volatilities and low credit market frictions, as leverage and hence stationary distribution in such environments are more sensitive to interest rate changes. In terms of macroprudential regulations, bond liquidity can significantly relax the optimal tightness of leverage constraints, while also moderately increase the optimal tax on credit. Lastly, this paper distinguishes between public and private liquidity, and explores the model’s fiscal policy implications.