Aggregate Consequences of Limited Contract Enforceability

Abstract

We study a general equilibrium model in which entrepreneurs fi- nance investment with optimal financial contracts. Because of enforce- ability problems, contracts are constrained ecient. We show that limited enforceability amplifies the impact of technological innovations on aggregate output. More generally, we show that lower enforceabil- ity 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.