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My co-author Thomas Drechsel (@td_econ) is on the academic Job Market this year with a paper on "Earnings-Based Borrowing Constraints
and Macroeconomic Fluctuations". Here is a short summary, be sure to check his profile! personal.lse.ac.uk/drechsel/ (thread)
and Macroeconomic Fluctuations". Here is a short summary, be sure to check his profile! personal.lse.ac.uk/drechsel/ (thread)
Looking at direct micro evidence on firm borrowing, Thomas points out that lenders typically restrict debt based on firm's earnings flows. Covenants, for example, are pervasive legal conditions written into loans that state that debt-to-EBIDTA cannot exceed certain limits.
The modern macro literature, which features financial frictions, has typically focused on COLLATERAL constraints to borrowing, but as Thomas points out, EARNINGS constraints are at least as common in US data as collateral ones...
The difference matters! Investment-specific shocks (which reduce the relative price of investment goods) will lead to MORE borrowing under earnings constraints, but LESS borrowing under collateral constraints!
Why? After an Investment-Specific shock, the PDV of dividends (which we know is tightly linked to the value of capital) falls, but the flow of earnings increases. So what limits your borrowing matters. This is a tight theoretical prediction that can be checked in the data!
And the data speaks quite clearly, after an IST shock, firm debt goes UP, not DOWN. No matter whether you look at it using Vector Autoregression methods on aggregate data...
...or whether you look at the cross section of firms in panel regressions where the IST shock is locally projected on different times of firms, there is strong support for the mechanism!
It also matters for aggregate dynamics. In an estimated New Keynesian DSGE model with both types of constraints, the estimated weight on the earnings constraint is VERY LARGE, and its presence substantially changes the transmission and amplification of other macro shocks!
What I really like about this paper is that the introduction of new MACRO mechanisms and frictions is strictly disciplined by direct MICRO evidence! The DSGE far too often has relied on ad-hoc mechanisms. It is refreshing to see work that takes the empirics seriously!
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