Thomas Drechsel (University of Maryland)

Abstract:

Microeconomic evidence on US corporate credit suggests a direct connection between firms’ current earnings and their access to debt. This paper formalizes this link through an earnings based constraint on firm borrowing and studies its macroeconomic implications. In a business cycle model, an earnings-based constraint implies that debt expands in response to investment shocks, whereas a collateral constraint implies that credit contracts. The paper verifies the empirical relevance of this differential prediction in macro and micro data. At the aggregate level, firm debt responds positively to investment shocks, which supports the economy-wide relevance of earnings-based constraints. At the micro level, firms that face earnings-based constraints indeed borrow more in response to investment shocks, while firms that pledge collateral borrow less. In an estimated quantitative model with nominal rigidities, earnings based constraints dampen the output response to fiscal shocks, whereas monetary shocks have stronger but less persistent effects compared to a model with collateral constraints.