Discussion Paper Series 2013-E-6

Financial Frictions, Capital Misallocation, and Structural Change

Naohisa Hirakata, Takeki Sunakawa

We develop a two-sector growth model with financial frictions to examine the effects of a decline in the working population ratio and change in the structure of household demand on sectoral TFP and structural change. Our findings are twofold. First, with financial frictions, a decline in labor input reduces the real interest rate and increases excess demand for borrowing, tightening collateral constraints at a given credit-to-value ratio and generating capital misallocation and lower sectoral TFP. Second, compared to the case with no financial frictions, such changes in sectoral TFP impede structural changes driven by the change in the structure of household demand.

Keywords: Financial frictions; heterogeneous firms; capital misallocation; total factor productivity; structural change

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2013 Bank of Japan All Rights Reserved.

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