On Entrepreneurial Risk–Taking and the Macroeconomic Effects of Financial Constraints

This paper deals with credit market imperfections and idiosyncratic risks in a two–sector heterogeneous agent dynamic general equilibrium model of occupational choice. We focus especially on the effects of tightening financial constraints on macroeconomic performance, entrepreneurial risk–taking, and social mobility. Contrary to many models in the literature, our comparative static results cover a broad range for borrowing constraints, from an unrestrained to a perfectly constrained economy. In our baseline model, we find substantial gains in output, welfare, and wealth equality associated with credit market improvements. The marginal gains from relaxing constraints are largest for empirically relevant debt–equity ratios. Interestingly, the entrepreneurship rate and social mobility respond non–monotonically to a change in the tightness of financial constraints. The results crucially depend on the degree of income persistence and feedback effects in general equilibrium, where optimal firm sizes and the demand for credit are determined endogenously.