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Credit Constraints, Firms' Precautionary Investment, and the Business Cycle

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  • Ander Pérez Orive

Abstract

This paper studies the macroeconomic implications of firms'precautionary investment behavior in response to the anticipation of future financing constraints. Firms increase their demand for liquid and safe investments in order to alleviate future borrowing constraints and decrease the probability of having to forego future profitable investment opportunities. This results in an increase in the share of short-term projects that produces a temporary increase in output, at the expense of lower long-run investment and future output. I show in a calibrated model that this behavior is at the source of a novel and powerful channel of shock transmission of productivity shocks that produces short-run dampening and long-run propagation. Furthermore, it can account for the observed business cycle patterns of the aggregate and firm-level composition of investment.

Suggested Citation

  • Ander Pérez Orive, 2010. "Credit Constraints, Firms' Precautionary Investment, and the Business Cycle," Working Papers 506, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:506
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    More about this item

    Keywords

    Investment Choice; financial frictions; Business cycles; Idiosyncratic Production Risk;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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