Business Cycle Effects of Credit and Technology Shocksin a DSGE Model with Firm Defaults

This paper proposes a theoretical framework to analyze the impacts of credit and technologyshocks on business cycle dynamics, where firms rely on banks and households for capitalfinancing. Firms are identical ex ante but differ ex post due to different realizations of firmspecific technology shocks, possible leading to default by some firms. The paper advances anew modelling approach for the analysis of financial intermediation and firm defaults thattakes account of the financial implications of such defaults for both households and banks.Results from a calibrated version of the model highlight the role of financial institutions in thetransmission of credit and technology shocks to the real economy. A positive credit shock,defined as a rise in the loan to deposit ratio, increases output, consumption, hours andproductivity, and reduces the spread between loan and deposit rates. The effects of the creditshock tend to be highly persistent even without price rigidities and habit persistence inconsumption behaviour....