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Misallocation measured by dispersion in revenue to inputs ratio rises in recessions. Can single aggregate TFP shocks drive business cycles that are consistent with countercyclical misallocation and credit spread? This paper tries to study this question using a quantitative general equilibrium model populating with heterogenous firms facing endogenous default risk. I make two assumptions that deviate from a frictionless economy and drive the main results. First, fixed capital is subject to partial irreversibility and indivisibility, implying that it can’t be sold in pieces but can be sold entirely with a haircut. Second, working capital has to be financed in advance though flexible to adjust. The quantity rigidity and financial frictions together prevent firms from adjusting inputs and produce efficiently. Therefore, default risks are higher and rise in recessions particularly for firms with higher leverage conditional on net worth. Endogenous liquidation leads to further pressure on collateral value through active capital price.