Financial Fragility, Patterns of Firms' Entry and Exit and Aggregate Dynamics

In macroeconomic models with financial constraints (see, for instance, Greenwald and Stiglitz, 1993; Bernanke, Gertler and Gilchrist,1998; Kiyotaki and Moore,1997) firms' supply decisions depend upon the degree of financial robustness/fragility, which is identifed and measured in different ways. In the theoretical framework put forward by Greenwald and Stiglitz (GS hereafter), for example, financial fragility is due to the presence of bankruptcy risk. GS implicitly assume, however, that the number of firms is constant. In this paper we abandon the one-to-one replacement assumption and allow for an unconstrained turnover of firms. In particular we exploit the presence of bankruptcy risk in a theoretical framework a la Greenwald-Stiglitz (Delli Gatti, Gallegati and Palestrini, 2000) to model an endogenous flow of exiting firms. As to the flow of entrants, we assume that it is influenced by current macroeconomic conditions (summarized by the number of surviving, non-bankrupt firms) and by stochastic factors. This entry-exit pattern of industrial dynamics will affect the evolution of the distribution of firms according to the degree of financial robustness/fragility which in turn will affect aggregate outcomes. In our opinion, in fact, firms' heterogeneity plays a crucial role in determining the macroeconomic performance