Credit Constraints and Innovation Investment

Credit constraints bind for entrepreneurs: Patient households provide seed funding but entrepreneurs face borrowing limits that restrict optimal R&D investment

Quality ladder innovation generates endogenous growth: R&D expenditure creates probabilistic quality improvements with cost increasing in technological sophistication

Venture capital structure affects innovation dynamics: The equity-sharing arrangement between patient households and entrepreneurs creates different incentives compared to standard debt financing

Arrow replacement effect modified: Credit constraints can override the standard result that incumbents have lower innovation incentives than entrants

Two-agent DSGE model: Patient households (high β) and impatient entrepreneurs (low β) with different time preferences

Schumpeterian quality ladder: Innovation increases sectoral quality levels by factor λ with probability η(z^E_t)

Credit market friction: Entrepreneurs can only borrow against expected firm value, creating financing constraints

Endogenous mark-ups: Monopolistic competition with price mark-ups determined by number of firms per sector

Calibration to business cycle moments: Model parameters chosen to match stylized facts about R&D and output volatility

Financial development matters for growth: Improving access to credit for entrepreneurs can boost aggregate innovation and long-run growth

Venture capital policy: Policies supporting equity financing may be more effective than debt market interventions for innovation

Cyclical innovation patterns: Credit constraints can explain why R&D behaves differently from theoretical predictions during business cycles

Firm size and innovation: The model suggests optimal firm size depends on the balance between financing constraints and market power effects