The Net Worth Trap: Investment and Output Dynamics in the Presence of Financing Constraints

51 Pages Posted: 26 Apr 2016

See all articles by Jukka Isohätälä

Jukka Isohätälä

Loughborough University

Alistair Milne

Loughborough University - School of Business and Economics

Donald Robertson

Cambridge University - Department of Economics

Date Written: 2014

Abstract

We study the impact of financing constraints on investment and output dynamics, in a continuous time setting with output a linear function of capital. Decline of net worth reduces investment and, if firms can rent capital to unconstrained outside investors, can create a 'net worth trap' with both investment and output falling below normal levels for long time periods. We provide a detailed account of our model solution and discuss both the economic intuition underpinning our results and the implications for macroeconomic modeling. Keywords: cash flow management, corporate prudential risk, financial accelerator, financial distress, induced risk aversion, liquidity constraints, liquidity risk, macroeconomic propagation, multiperiod financial management, non-linear macroeconomic modelling, Tobin's q, precautionary savings

Keywords: E44

Suggested Citation

Isohätälä, Jukka and Milne, Alistair K. L. and Robertson, Donald, The Net Worth Trap: Investment and Output Dynamics in the Presence of Financing Constraints (2014). Bank of Finland Research Discussion Paper No. 26/2014, Available at SSRN: https://ssrn.com/abstract=2770431 or http://dx.doi.org/10.2139/ssrn.2770431

Jukka Isohätälä (Contact Author)

Loughborough University

Ashby Road
Nottingham NG1 4BU
Great Britain

Alistair K. L. Milne

Loughborough University - School of Business and Economics ( email )

Epinal Way
Loughborough
Leicestershire, LE11 3TU
United Kingdom

Donald Robertson

Cambridge University - Department of Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DE
United Kingdom
+44 1223 335275 (Phone)
+44 1223 335475 (Fax)

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