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Chain Reactions, Trade Credit and the Business Cycle

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  • Miguel Cardoso-Lecourtois

Abstract

Firms in poor countries often tend to rely on alternative sources of financing different than banks. We show that borrowing constraints lead to financial arrangements between firms that can amplify the effect of liquidity or productivity shocks in the economy. In particular, we focus on the effects of trade credit. Widespread borrowing and lending between firms implies the establishment of relationships that can serve as a way to transmit economic shocks. In other words, trade credit creates a network of firms, all of them linked by the credit given to each other and all of them exposed to the temporary problems the others might have. We develop in this chapter a model based on the ideas of Kiyotaki and Moore (1997). Our model however, is a general equilibrium version of theirs that deals with the aggregate consequences that temporary productivity or liquidity shocks might have on the whole economy. Our results show that in a carefully calibrated model, the effects of these credit chains are quite important. In particular, in an economy like Mexico where 65% of firms claim their main source of financing to be other firms, the impact of productivity shocks is significant and three times bigger than in an economy with levels of trade credit use close to the US case

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 331.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:331

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Keywords: Trade Credit; Output Volatility;

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  1. Raymond Fisman & Inessa Love, 2003. "Trade Credit, Financial Intermediary Development, and Industry Growth," Journal of Finance, American Finance Association, vol. 58(1), pages 353-374, 02.
  2. Acemoglu, Daron & Scott, Andrew, 1997. "Asymmetric business cycles: Theory and time-series evidence," Journal of Monetary Economics, Elsevier, vol. 40(3), pages 501-533, December.
  3. Quintin, Erwan, 2008. "Limited enforcement and the organization of production," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 1222-1245, September.
  4. Neumeyer, Pablo Andrés & Perri, Fabrizio, 2004. "Business Cycles in Emerging Economies: The Role of Interest Rates," CEPR Discussion Papers 4482, C.E.P.R. Discussion Papers.
  5. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
  6. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  7. Ellen R. McGrattan, 1998. "Application of weighted residual methods to dynamic economic models," Staff Report 232, Federal Reserve Bank of Minneapolis.
  8. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  9. Demirguc-Kunt, Asli & Maksimovic, Vojislav, 2001. "Firms as financial intermediaries - evidence from trade credit data," Policy Research Working Paper Series 2696, The World Bank.
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