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Liquidity Flows and Fragility of Business Enterprises

  • Author(s): den Haan, Wouter J.
  • Ramey, Garey
  • Watson, Joel
  • et al.
Abstract

This paper develops a macroeconomic model in which investable assets flow to entrepreneurs through long-term relationships with lenders. Low asset flows cause relationships to break up due to insufficient liquidity. Multiple Pareto ranked steady states emerge from complementarity between financial intermediation, reflected by the number of relationships, and households' incentives to provide assets. This complementarity also serves as a mechanism for propagating aggregate shocks. Financial collapse may become inescapable if a shock destroys sufficiently many relationships.

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