The Misfortune of Nonfinancial Firms in a Financial Crisis: Disentangling Finance and Demand Shocks

If a non-financial firm does not do well in a financial crisis, it could be due to either a contraction of demand for its output or a contraction of supply of external finance. We propose a framework to assess the relative importance of the two shocks, and apply it to the 2007-2008 crisis. We find robust evidence suggesting that both channels are at work, but that a finance shock is economically more important in understanding the plight of non-financial firms.