Recovery Dynamics: An Explanation from Bank Lending and Entrepreneur Entry

Economic recoveries can be slow, fast, or involve double dips. This paper provides an explanation based on the dynamic interactions between bank lending standards and firm entry selection. In the model, bank lending standards refer to both how banks screen borrowers with unknown quality and whether well-qualified borrowers are credit rationed, and firm entry selection refers to the mechanism through which financing conditions select firms of different quality to enter the lending market. Recoveries are slower when high-quality borrowers postpone their investments, which occurs if the borrower pool has lower quality on average. Double dips can occur when banks endogenously produce information, which increases waiting benefits discontinuously. The model is consistent with both aggregate- and industry-level data.