Decoupling and recoupling

Anton Korinek

"We develop a stylized model that captures the phenomena of decoupling and recoupling in an environment where heterogeneous entrepreneurial sectors face financial constraints in their relationship with a common set of lenders. In response to adverse shocks, a financially constrained sector must reduce its borrowing and cut down on production. In particular, as the constrained sector absorbs less and less capital, the real interest rate in the economy declines. Other sectors that compete for the same inputs (including capital) thus experience lower costs, which boosts investment, output, and profits, reflecting the phenomenon of "decoupling." As long as the shock is small, the entrepreneurial sector repays what is owed and the lenders' ability to supply funds is unaffected. For large shocks, however, the constrained sector is no longer able to honor its debts in full and lenders...