Credit constraints, firms' precautionary investment and the business cycle
AbstractThis paper studies the macroeconomic implications of firms' investment composition choices in the presence of credit constraints. Following a negative and persistent aggregate productivity shock, firms shift into short-term investments because they produce more pledgeable output and because they help alleviate future borrowing constraints. This produces a short-run dampening of the effects of the shock, at the expense of lower long-term investment and future output, relative to an economy with no credit market imperfections. The effects are exacerbated by a steepening of the term structure of interest rates that further encourages a shift towards short-term investments in the short-run. Small temporary shocks to the severity of financing frictions generate large and long-lasting effects on output through their impact on the composition of investment. A positive financial shock produces much stronger effects than an identical negative shock, while the responses to positive and negative shocks to aggregate productivity are roughly symmetric. Finally, the paper introduces a novel explanation for the countercyclicality of financing constraints of firms.
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Bibliographic InfoPaper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1237.
Date of creation: Sep 2010
Date of revision: Nov 2012
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Web page: http://www.econ.upf.edu/
Investment composition; Financial frictions; Business cycles; Idiosyncratic production risk; Firm heterogeneity;
Find related papers by JEL classification:
- D92 - Microeconomics - - Intertemporal Choice - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-16 (All new papers)
- NEP-BEC-2010-10-16 (Business Economics)
- NEP-DGE-2010-10-16 (Dynamic General Equilibrium)
- NEP-MAC-2010-10-16 (Macroeconomics)
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