DP4173 Aggregate Consequences of Limited Contract Enforceability

Author(s): Thomas F Cooley, Ramon Marimon, Vincenzo Quadrini
Publication Date: January 2004
Keyword(s): aggregate volatility, amplification, contract enforceability, G00
JEL(s): E30
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4173

We study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts. Because of enforceability problems, contracts are constrained efficient. We show that limited enforceability amplifies the impact of technological innovations on aggregate output. More generally, we show that lower enforceability of contracts will be associated with greater aggregate volatility. A key assumption for this result is that defaulting entrepreneurs are not excluded from the market.