Financial Frictions and the Persistence of History: A Quantitative Exploration

Financial Frictions and the Persistence of History: A Quantitative Exploration

This paper shows that financial frictions matter for the transition dynamics of the macroeconomy. Take, for example, the miracle and post-communist economies, whose growth experiences do not conform to the predictions of the standard neoclassical growth model: Their growth and investment rates were low initially and peaked in latter stages, while the real interest rates tended to be low along the transition. We incorporate financial frictions and resource misallocation into an otherwise-standard growth model, and account for the observed growth dynamics. We calibrate the model by matching its stationary equilibrium to the US data on standard macroeconomic aggregates, wealth distribution, and firms’ external financing. Our model economy converges slowly to the steady state, with the interest rate and the investment rate starting low and rising over time. We also obtain a new result on heterogeneity and macroeconomic dynamics: Even though strict approximate aggregation—that relies only on unconditional first moments—does not hold in our economy, the effect of heterogeneity on aggregate dynamics is well captured by a small number of conditional moments.