Macroeconomic Effects of Financial Shocks

TLDR

The authors develop a model of debt and equity financing to examine how financial shocks influence real and financial variable dynamics. The model incorporates debt and equity financing to analyze the impact of financial shocks on real and financial variables. The study finds that equity payouts are procyclical, debt payouts countercyclical, and that financial shocks and tightening credit conditions significantly contributed to the dynamics of real and financial variables and to recessions in 2008–2009, 1990–1991, and 2001. JEL codes: E23, E32, E44, G01, G32.

Abstract

We document the cyclical properties of US firms' financial flows and show that equity payout is procyclical and debt payout is countercyclical. We then develop a model with debt and equity financing to explore how the dynamics of real and financial variables are affected by “financial shocks.” We find that financial shocks contributed significantly to the observed dynamics of real and financial variables. The recent events in the financial sector show up as a tightening of firms' financing conditions which contributed to the 2008–2009 recession. The downturns in 1990–1991 and 2001 were also influenced by changes in credit conditions. (JEL E23, E32, E44, G01, G32)