Credit Markets and the Propagation of Monetary Policy Shocks



the old steady state during the whole transition. This means that the increase in
labor is originated through an increase in the demand for labor. The normalized
price increases slowly towards the new steady state level. Figure 4 includes the
evolution of real financial assets. There is a reduction of deposits at the same time
as an increase in loans. As the government reduces its borrowing, the reduction in
interest rates puts downward pressure on the demand for real deposits as well as
the supply of loans increase as financial intermediaries try to divert resources to
entrepreneurs. This is why Figure 1 showed a reduction in the asset levels of the
economy.

Figures 5 and 6 give an idea of the internal mechanism generating this tran-
sition. Figure 5 presents the evolution of the fraction of entrepreneurs who are
financially constrained. At the initial steady state, this variable took a value of
23 percent. On impact, it changes to 22 percent and stays low relative to the old
steady state. This is a consequence of the reduction in interest rates which relaxes
the financial constraint for some entrepreneurs.

In Figure 6, we compare the responses of three entrepreneurs who differ on their
initial level of accumulated assets. The top panel is generated as follows. First, we
look at the wealth distribution of assets in the initial steady state and compute the
average wealth level of the entrepreneurs in the bottom docile. Second, we follow
the trajectory of an entrepreneur with that level of assets who keeps a productivity
of z = 2.25 permanently. We choose this number because the largest fraction of
entrepreneurs (54 percent) is concentrated at that skill level. Because of his low
level of initial assets, this agent starts financially constrained. So he enters in
a path where he is accumulating assets and, given that he keeps a high level of
productivity, eventually becomes unconstrained. Third, we look at the trajectory
of this same agent but only after the monetary shock hits the economy in the first
period. The graph is the ratio of the two trajectories. So, the figure says that
this agent hires 3 percent more labor in the first period after the shock than what
he would otherwise have hired had the shock not occurred. The middle panel
represents the same exercise with an entrepreneur with the same skills but with
the average capital level of all entrepreneurs. The bottom panel represents the
entrepreneur with the average asset level of the top docile of the entrepreneurs.
To understand these graphs it is important to notice that these agents had different
paths in the original steady state. The poor entrepreneur was accumulating assets
to reach a level that will make him unconstrained and run his firm at the optimal
level. He reached such a level of assets in period 12. Thus, as he was increasing
his wealth, so did his demand of capital and labor and his production. On the
contrary, the average and rich entrepreneurs were not constrained by their wealth
and were running their firms at the optimal level. The input demands for these
agents only depended on their skill level. As we maintained their productivities
constant they had constant profiles for output and inputs.

23



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