The U.S. Great Recession featured a large decline in output and labor, tighter financial conditions, and a large increase in firm growth dispersion. We build a model in which increased volatility at the firm level generates a downturn and worsened credit conditions. The key idea is that hiring inputs is risky because financial frictions limit firms' ability to insure against shocks. An increase in volatility induces firms to reduce their inputs to reduce such risk. Out model can generate most of the decline in output and labor in the Great Recession and the observed increase in firms' interest rate spreads.
- E44 - Financial Markets and the Macroeconomy
- E32 - Business Fluctuations; Cycles
- E23 - Macroeconomics: Production
- E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
- D53 - General Equilibrium and Disequilibrium: Financial Markets
- D52 - Incomplete Markets
- Federal Reserve Bank of Minneapolis. Research Department
- Federal Reserve Bank of Minneapolis
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