Liquidity constraints hinder firm investment, reducing capital stock and economic growth.
The article explores how financial constraints impact a company's investment decisions. By creating a model that considers these constraints, the researchers found that firms' ability to raise equity is significantly reduced in imperfect capital markets. This leads to lower investment levels compared to free markets. When firms can use fresh equity for investment, their capital stock increases by about 6% over 20 years. Additionally, interest rate changes have a lasting effect on capital accumulation.