This paper examines the impact of credit frictions arising from firm-level default risk on aggregate economic performance. We build a micro-to-macro model with heterogeneous firms and sector-specific production functions, showing that perceived default risk is a sufficient statistic for credit frictions. Using UK administrative data (2004–2019) matched to S&P risk measures, counterfactual estimates reveal that relaxing frictions raises output by 25% and wages by 23%. Ignoring equilibrium wage adjustments overstates output gains, while fixed-capital misallocation approaches understate them. Most gains reflect aggregate capital accumulation. Credit frictions remain above pre-crisis levels, reshape firm size dynamics, increase misallocation across firms, and dampen productivity growth over time.
Timothy Besley, Peter John Lambert, Isabelle Michalski-Roland and John Van Reenen
29 July 2026 Paper Number CEPDP2201
Download PDF - The equilibrium impact of credit frictions: evidence from default risk using firm-level data
This work is published under POID and the CEP's Growth programme.