FIRM SIZE AND BUSINESS CYCLES WITH CREDIT SHOCKS

Abstract I study the macroeconomic implications of firm heterogeneity in the presence of financial frictions. I build a business cycle model in which firm size is jointly determined by idiosyncratic productivity and collateral constraints. I estimate skewed idiosyncratic shocks and align the model with the evidence on firm size, leverage, and investment moments. The extent of resource misallocation is driven by a small number of highly productive but financially constrained firms. A credit shock severely affects such firms, further constraining their ability to borrow. This generates a large and persistent economic downturn that is comparable to the Great Recession.