Flexibility and Frictions in Multisector Models

This paper documents two facts: (i) elasticities of substitution in production vary
significantly across sectors, with manufacturing sectors being generally less flexible than
service sectors, and (ii) during the Great Recession the rise in bond spreads varied
systematically with these elasticities. Specifically, more flexible sectors paid lower
spreads during the Great Recession. Moreover, among the less-flexible manufacturing
sectors, sectors with relatively high flexibility and high debt saw their spreads rise less
than average, while among the more-flexible service sectors the sectors with relatively
high flexibility and high debt saw their spreads rise more. We interpret these results
using a simple two-sector model with working capital constraints, and show that the
model replicates these observations if manufacturing sectors face constraints on their
purchases of intermediates while services face constraints on their purchases of
labor/capital. The dynamics of intermediate prices and quantities support our results, as
does a quantitative investigation of a 62-sector version of the US economy.