Open AccessCredit Frictions and The Cleansing Effect of Recessions
Author(s) -
Osotimehin Sophie,
Pappadà Francesco
Publication year - 2017
Publication title -
the economic journal
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.683
H-Index - 160
eISSN - 1468-0297
pISSN - 0013-0133
DOI - 10.1111/ecoj.12319
Subject(s) - recession , economics , shock (circulatory) , monetary economics , productivity , macroeconomics , medicine
Recessions are conventionally considered as times when the least productive firms are driven out of the market. How do credit frictions affect this cleansing effect of recessions? We build and calibrate a model of firm dynamics with credit frictions and endogenous entry and exit to investigate this question. We find that there is a cleansing effect of recessions in the presence of credit frictions, despite their effect on the selection of exiting and entering firms. This result holds true regardless of the nature of the recession: average firm‐level productivity rises following a negative aggregate productivity shock, as well as following a negative financial shock.