We present a model with heterogeneous firms, in which credit constraints may give rise to self-fulfilling, sunspot … constrained by expected equity value. Interactions between debt and equity value made possible by credit constraints generate a … credit externality, which leads to procyclical total factor productivity (TFP) and, with sufficiently high cost of financial …

Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints … in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a … and we allow productive agents to be credit-constrained. A combination of these two features enables our model to …