Aggregate Consequences of Limited Contract Enforceability

Abstract

We study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts. Because of enforceability problems, contracts are constrained efficient.We show that limited enforceability amplifies the impact of technological innovations on aggregate output. More generally, we show that lower enforceability of contracts will be associated with greater aggregate volatility. A key assumption for this result is that defaulting entrepreneurs are not excluded from the market.