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Oxf Rev Econ Policy 1999; 15:39-51
© 1999 Oxford University Press and Oxford Review of Economic Policy Ltd

Article

Financial distress and the business cycle

J Suarez0
O Sussman1
0 CEMFI
CEPR
1 Ben-Gurion University of the Negev
MCER

Abstract

In this paper we argue that firms' financial distress should play a greater role in the macroeconomic analysis of the business cycle. We provide a non-technical account of a general equilibrium model that exhibits financially-driven equilibrium cycles. We show that the empirical evidence is widely supportive of the key hypothesis and implications of our approach. We use the model in order to evaluate the effects of several policy measures. It turns out that deepening the market for second-hand capital goods, subsidizing the interest payments of companies which start up when financial conditions are tight, and bailing out some companies in default can indeed 'stabilize' the economy. By way of generalization, we may say that the policy reaction to a financially driven bust should be accommodating.


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