On the importance of household versus firm credit frictions in the Great Recession

Abstract

Although a credit tightening is commonly recognized as a key determinant of the Great Recession, to date, it is unclear whether a worsening of credit conditions faced by households or by firms was most responsible for the downturn. Some studies have suggested that the household-side credit channel is quantitatively the most important one. Many others contend that the firm-side channel played a crucial role. We propose a model in which both channels are present and explicitly formalized. Our analysis indicates that the household-side credit channel is quantitatively more relevant than the firm-side credit channel. We then evaluate the relative benefits of a fixed-sized transfer to households and to firms that improves each group's access to credit. We find that the effects of such a transfer on employment are substantially larger when the transfer targets households rather than firms. Hence, we provide theoretical and quantitative support to the view that the employment decline during the Great Recession would have been less severe if instead of focusing on easing firms' access to credit, the government had expended an equal amount of resources to alleviate households' credit constraints.

Credit Supply, Firms, and Earnings Inequality

“…Few papers consider the role of firm credit in determining employment and pay through the labor demand channel in a frictional labor market. In this regard, closest to our theoretical framework are those by Wasmer and Weil (2004) and Kehoe et al (2019Kehoe et al ( , 2020. Like them, we introduce credit frictions into a searchand-matching environment.…”

Would Macroprudential Regulation Have Prevented the Last Crisis?

“…The repo liabilities of broker-dealers increased from $1.4 trillion in 2001 to $3.0 trillion in 2007. 1 Moreover, an increasing fraction of repos were backed by low-quality securities. Figure 1 shows the rise in repo funding, along with commercial paper, another form of funding that experienced rapid growth over this period.…”

“…This growth was accompanied by an increased reliance on debt financing of the nonbank system. Short-term borrowing became more important, with the belief that it could be 1 Total repo liabilities for all types of institutions recorded in the Financial Accounts of the US data for end-2001 and 2007 were $2.2 trillion and $4.8 trillion, respectively. None of these numbers were readily available in the run-up to the crisis, as broker-dealers repo liabilities were only reported on a netted basis (Eichner, Kohn, and Palumbo 2013;Holmquist and Gallin 2014).…”

What Happened: Financial Factors in the Great Recession

“…In these studies, the financial accelerator mechanism remains operative, but the transmission of the crisis through the different sectors of the economy is much closer to what actually occurred. 4…”

“… Bernanke's (1983) classic analysis of the role of financial factors in the Great Depression provided motivation for this direction 4. Readers interested in some additional examples of macro modeling of financial crises might also look at Geanakopolos (2010), Jermann and Quadrini (2012), Christiano, Motto, and Rostagno (2014), Arellano, Bai, andKehoe (2016), and Iacoviella (2005).…”