Credit frictions and the cleansing effect of recessions

By Sophie Osotimehin and Francesco Pappadà

Recessions are conventionally considered as times when the least productive firms are driven out of the market. Do credit frictions hamper this cleansing effect of recessions? We build and calibrate a model of firm dynamics with endogenous exit and credit frictions to investigate this question. We find that, despite their distortionary effect on the selection of exiting firms, credit frictions do not reverse the cleansing effect of recession. Average idiosyncratic productivity rises following an adverse aggregate shock. Our results also suggest that recessions have a modest impact on average productivity whatever the level of credit frictions

Bernanke-Gertler meets Schumpeter, and neither seems to matter much. I was expecting the cleansing during recessions to be more important. As for frictions, it was not clear which way it would go, as more productive firms may face fewer frictions but frictions become more important in recessions, or something like that. In any case, it turns out that the popular claim that an occasional recession is good for the economy is not that true.

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