Macroeconomics of Partially Irreversible Investment with Financing Constraints

Abstract

This thesis investigates firm-level partially irreversible investment (assets are not fully resaleable) with financing constraints, in order to study asset liquidity, the impacts on financing these assets, firm-level investment and liquidation, and the effects on optimal policy designs (especially unconventional monetary policy on purchasing privately issued financial assets).

Chapter 1 studies why aggregate firm-level capital stock liquidation (selling of used assets plus mergers and acquisitions) is less in recessions, in contrast to the traditional creative-destruction theory. I investigate when unproductive firms liquidate capital stock if there are liquidation costs, and how financing constraints alter the liquidation decisions. Importantly, financing constraints make productive firms to hire fewer workers and demand less borrowing. Therefore, the equilibrium wage rate and interest rate will tend to be lower. A lower wage rate and a lower interest rate make holding capital more attractive to unproductive firms, such that liquidating capital stock will be prolonged. A recession generated by tightened financing constraints thus features less capital liquidation.

Chapter 2 shows how asset liquidity can be endogenous. We construct a tractable model with endogenous asset liquidity through search frictions between buyers and sellers, whose participations are equilibrium outcomes. The model shows that variations of transaction ease of financial assets can generate procyclical asset liquidity and the flight to liquid government bonds in recessions, while standard productivity shocks cannot. The model shed lights on why financial system can have large feed-back impacts on investment and production. This work is co-authored with Sören Radde.

Chapter 3 continues with liquidity frictions where there are partially resaleable privately issued financial assets and fully resaleable government bonds. It designs the optimal policy and shows that government holding of some privately issued assets (i.e., unconventional monetary policy) can fully avoid the liquidity frictions. Without the policy, private agents over-save in government bonds which make the bond rate unnecessarily low. A too low interest rate hurts investment from firms who use bonds as funding sources. The unconventional policy can raise the interest rate by using returns from privately issued financial claims. Aggregate investment and consumption can thus increase to the first-best level.