Gertler and Gilchrist [3], Carlstrom and Fuerst [7], Fuerst [12], Hubbard [13],
and Kiyotaki and Moore [15]). These papers, however, are representative agents
models. More recently, several papers study economies where financial constraints
interact with firms heterogeneity. In these models the endogenous distribution
of capital across firms is an important element in the aggregate properties of the
economies analyzed. In particular, Cooley et al. [9] develop a model with heteroge-
neous entrepreneurs subject to financial constraints to study the role of repudiation
of financial contracts for the diffusion and propagation of technological progress.
Jermann and Quadrini [14] use the same model as Cooley et al. [9] to analyze the
effects of an improvement of expectations about technological innovations. They
show that just the prospects of an increase in the growth of productivity can gen-
erate an expansionary episode because of the benefits from reallocating capital
between constrained and unconstrained firms.
In another paper related to ours, Kiyotaki and Moore [16] analyze the busi-
ness cycle properties derived from monetary policy shocks. They are also able to
generate an endogenous distribution of firms but the mechanism is different from
ours. The main focus of their paper is to have money demanded from first princi-
ples. To obtain that, investors in their economy receive random opportunities to
produce new capital goods from consumption goods. These idiosyncratic shocks
generate the heterogeneity across investors and the need to transfer funds from
the agents without investment opportunities to the ones who have them. How-
ever, old capital is illiquid in the sense that it cannot be fully used to finance these
investment projects. Under these circumstances, money may have a value in such
an economy since it can speed up trade among agents. The authores then look at
the qualitative properties of the dynamic response of the economy to technology
and monetary shocks but do not perform any quantitative analysis.
Another paper that is close to ours is Cooley and Quadrini [10]. These au-
thors construct a model where firms heterogeneity results from borrowing limits
on the funds needed by firms to expand their business. The model incorporates
a nominal sector and a limited participation constraint on the part of households
when deciding their deposits at financial intermediaries. This constraint allows the
central bank to affect the nominal interest rate in the short run and to induce a
persistent movement in output through the financial decisions of firms. They find
that although quantitatively the aggregate impact is small, the response of small
and large firms differs substantially.
The transmission mechanism in our model is similar to the one in Cooley et
al. [9], Jermann and Quadrini [14], and Monge [20]. That is, a financial constraint
makes entrepreneurs with low levels of assets run their firms at a smaller size than
what is optimal. Thus, any perturbation that reduces the cost of capital is expan-
sionary and, as assets take time to accumulate, the response of constrained firms
propagate over time. However, compared with these three papers, we concentrate