DP15690 Constrained-Efficient Capital Reallocation

Author(s): Andrea Lanteri, Adriano A. Rampini
Publication Date: January 2021
Keyword(s): capital reallocation, Collateral, constrained efficiency, Investment Subsidies, Pecuniary externalities
JEL(s): D51, E22, E44, G31, H21
Programme Areas: Financial Economics, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15690

We analyze the constrained-efficient allocation in an equilibrium model of investment and capital reallocation with heterogeneous firms facing collateral constraints. The model features two types of pecuniary externalities: collateral externalities, because the resale price of capital affects firms' ability to borrow, and distributive externalities, because buyers of old capital are more financially constrained than sellers, consistent with empirical evidence. We show analytically and quantitatively that the equilibrium price of old capital is inefficiently high in general, because the distributive pecuniary externality exceeds the collateral externality, by a factor of two in the calibrated model. New investment generates a positive aggregate externality by reducing the future price of old capital, fostering reallocation toward more constrained firms. The constrained-efficient allocation induces a consumption-equivalent welfare gain of 5% compared to the competitive equilibrium, and can be implemented with subsidies on new capital and taxes on old capital.