Trade credit in the form of delayed input payments is an important source of financing for all types of firms. Empirical evidence on business cycle patterns and the usage of trade credit in the US economy suggests that trade credit comoves strongly with GDP and was severely affected at the onset of the 2008-2009 Financial Crisis. Motivated by these observations, this thesis studies the role of trade credit for the propagation of financial shocks in a production network and its implications for aggregate and sectoral outcomes.

To this end, I introduce a static quantitative multisector model featuring trade in intermediate inputs and endogenous trade credit linkages and costs between representative firms in each sector. Firms face working capital constraints and are required to finance their production costs using both bank and supplier credit. In response to a tightening of credit conditions, the endogenous adjustment in the volume and cost of trade credit captures two counteracting mechanisms: (1) Firms smooth interest rate shocks by substituting bank and supplier finance. (2) Any increase in the interest rate that a firm charges on trade credit tightens the financing terms of its customers thereby amplifying financial shocks. In equilibrium, the working capital constraint distorts the demand for production inputs and aggregate output as common to models with distortions. The interdependency of credit distortions further affects the propagation of financial shocks and it is shown that sectors extending a lot of trade credit to their customers relative to their own financing needs play a crucial role in the transmission of shocks to the cost of external funds.

In a quantitative application of the model to the US economy during the crisis, simulations featuring financial shocks only show that the model captures approximately a third of the drop in output, half of which can be attributed to the existence of trade credit linkages alone. I also show that the ability of firms to adjust their borrowing portfolio overall decreases aggregate volatility by less than two percent. This suggests that the smoothing mechanism of trade credit was operative, though small. In a final application, I quantify the predictions of the model and show that firms acting as important financial intermediaries for their customers are systemically important and generate large spillovers.