Consumer Welfare and Product Creation: The Credit Supply Channel

I show that firms that face a reduction in credit supply reduce product creation, by using variation from US banks' exposure to the mortgage market to instrument for credit supply. The magnitude is substantial: firms facing a one-standard-deviation decrease in credit supply offered 10% fewer products. Furthermore, I show that the reduction in product offerings derives from the limited creation of new products rather than the destruction of existing ones. Motivated by these findings, I develop a model to investigate the equilibrium responses of consumers and firms. I estimate that the reduction in credit supply is responsible for a 1% drop in consumer welfare because of reduced product creation. Two types of equilibrium response are responsible for welfare loss that is smaller than a "naive" interpretation of the reduced form estimates: first, in equilibrium, consumers substitute products with other available products in the same category; and second, in equilibrium, firms' new products have lower "appeal" (quality or taste) relative to existing products.