By R. Glenn Hubbard
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Extra info for Asymmetric Information, Corporate Finance, and Investment (National Bureau of Economic Research Project Report)
37. Relaxing this condition would complicate the analysis without altering its fundamental conclusions. 38. The same results apply, of course, to this noncredit rationed IS curve. 39. This assumes that the increase in the supply of government debt is not completely offset by an increase in demand for government debt in anticipation of higher future taxes. e. higher government spending or lower taxes) are not considered, the change should be interpreted in terms of a comparison of a high-debt-economy (for historical reasons) to a low-debt economy.
For the levels of a above the curve, k will be increasing. A second steady-state relationship exists between k and a and can be de- 33 Macroeconomic Models with Equity and Credit Rationing a EaUITY DEMAND a* EFFECT OF INCREASED UNCERTAINTY -&-----. EaUITY SUPPLY k* k Fig. 4 Long-run steady state scribed as an equity supply curve. Higher levels of both the capital stock and equity tend to increase output, drive up wages, and ultimately reduce profit rates and retained earnings per worker. Since retained earnings are the source of equity growth and since equity per capita must grow in steady-state conditions at a proportional rate n, the steady-state equity demand relationship is (10) na = h(k, a), hI < 0, h2 < 0, which is a downward sloping curve (see fig.
I4 Increased uncertainty about future profitability has an opposite effect. Greater uncertainty increases both the absolute and incremental risk of bankruptcy under quite general conditions at any level of investment (output) and firm equity. Thus, firms respond by lowering investment (and output) since they cannot absorb the increased risks by issuing more equity. Complete specification of the output and investment model then requires an equation describing the evolution of equity levels. Substitution from the definitions of ht into the definition of at yields iit = Ptqt - (l+rt)(wtft-at-I)· Thus, firm equity levels in period t are firm equity levels in period t - 1 plus profits (including a shadow return on at-I).