Financial frictions drive firm productivity differences, TFP variance
A new FEDS paper models how financial frictions cause productivity differences across firms, widening dispersion in downturns. The model shows this misallocation accounts for 30 percent of aggregate TFP variance at business-cycle frequencies.
Endogenous TFP from firm sorting
A new representative-agent model from the Federal Reserve Board demonstrates how financial frictions drive endogenous productivity dispersion across firms.
Each firm possesses a private production efficiency and a financial intermediation technology.
Due to private information, all firms initially receive an equal share of household savings.
In a secondary market, firms then sort themselves into lenders, strategic defaulters, or producers based on their productivity.
This sorting mechanism, influenced by aggregate macroeconomic conditions, generates endogenous dynamics for aggregate Total Factor Productivity (TFP).
The model estimates that approximately 30 percent of the variance of TFP at business-cycle frequencies is endogenous, with about one-third of this component stemming from strategic default.
This tractable framework can be embedded in standard business-cycle models.
Strategic default amplifies TFP dynamics
The model's tractability allows integration into standard business-cycle frameworks with minimal additional equations.
It captures strategic default as an equilibrium outcome, quantitatively significant.
This variation accounts for roughly one-third of the endogenous TFP component, amplifying it by concentrating production among high-productivity firms and stabilizing its dynamic path.
Strategic default arises when low-productivity firms divert borrowed funds to an outside option.
This moral hazard margin influences both the strategic default rate and the average productivity of producing firms.
The model successfully replicates key features of U.S. data, including productivity dispersion narrowing with GDP growth and increased business loan delinquencies during economic downturns or high real interest rates.