Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/80797 
Year of Publication: 
2013
Series/Report no.: 
Bank of Canada Working Paper No. 2013-19
Publisher: 
Bank of Canada, Ottawa
Abstract: 
This paper proposes a theoretical framework to analyze the relationship between credit shocks, firm defaults and volatility, and to study the impact of credit shocks on business cycle dynamics. Firms are identical ex ante but differ ex post due to different realizations of firm-specific technology shocks, possibly leading to default by some firms. The paper advances a new modelling approach for the analysis of firm defaults and financial intermediation that takes account of the financial implications of such defaults for both households and banks. Results from a calibrated version of the model suggest that, in the steady state, a firm's default probability rises with its leverage ratio and the level of uncertainty in the economy. A positive credit shock, defined as a rise in the loan-to-deposit ratio, increases output, consumption, hours and productivity, and reduces the spread between loan and deposit rates. The effects of the credit shock tend to be highly persistent, even without price rigidities and habit persistence in consumption behavior.
Subjects: 
Business fluctuations and cycles
Credit and credit aggregates
Economic models
Financial Institutions
JEL: 
E32
E44
G21
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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