It is commonly assumed that binding collateral constraints amplify the impact of aggregate shocks on the economy. However, we show that when firms can hedge against aggregate risk with state-contingent lending contracts, binding collateral constraints no longer amplify shocks relative to the...

In models with financial frictions, state-contingent contracts stabilize the business cycle relative to contracts with predetermined rates. We show that this finding depends on whether predetermined rates are set in real or nominal terms. State-contingent contracts can amplify supply-driven...