Some unexpected consequences of financial frictions




Howes, Cooper Andersen

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This dissertation examines the role of financial frictions, monetary policy, and fiscal policy in determining aggregate economic outcomes.

The first chapter examines the role of credit reallocation in explaining the fact that the structural decline in US manufacturing over the past several decades has occurred disproportionately during recessions. Using syndicated loan-level data from DealScan, I document that manufacturing firms with open revolving credit lines involving Lehman Brothers at the time of its collapse in 2008 were persistently less likely to receive new loans and experienced reduced sales and employment after the crisis. As financial markets recovered, new credit was reallocated via the extensive margin to firms in higher-value industries such as software and healthcare services. A model with technology-driven structural change and fixed costs of establishing new financial relationships can match these facts and suggests the opportunity cost of providing credit to dying industries during times of crisis can be significant.

The second chapter studies how financial frictions impact the transmission of monetary policy to investment. I show that while investment in most sectors declines in response to a contractionary monetary policy shock, investment in the manufacturing sector increases. Using manually digitized aggregate income and balance sheet data for the universe of US manufacturing firms, I document that this increase is driven by the types of firms which are least likely to be financially constrained. A two-sector New Keynesian model with financial frictions can match these facts; unconstrained firms are able to take advantage of the decline in the user cost of capital caused by the monetary contraction while constrained firms are forced to cut back.

The third chapter analyzes how different types of tax changes can have different economic impacts. Using Congressional records, I decompose the plausibly exogenous legislative tax provisions into one of five categories: business marginal rate provisions, business investment incentives, other business provisions, individual marginal rate provisions, and other individual provisions. I find that the effects differ crucially depending on which types of taxes are being cut and that the most stimulative effects come from marginal rates for both individuals and businesses and investment incentives. This suggests that substitution effects, rather than income or demand-driven effects, are the primary driver of tax multipliers.



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