External financing and the role of financial frictions over the business cycle: Measurement and theory

Empirically, there is substantial cross-sectional variation in firms' use of external funds: roughly 80% of investment by privately held firms is financed externally, compared to 20% for publicly traded firms. In a model consistent with privately held and publicly traded firms' use of external funds, financial shocks generate only a modest response of output. This exercise casts doubt on the ability of financial shocks to generate significant economic fluctuations and emphasizes the role of non-financial linkages in understanding the importance of financial shocks.