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Propagation of Financial Shocks in an Input-Output Economy with Trade and Financial Linkages of Firms

Author

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  • Shaowen Luo

    (Virginia Technological Institute)

Abstract

Firms are connected through the production network, in which the production linkages coincide with financial linkages owing to delays in input payments that amount to a form of trade credit. In this paper, I investigate the roles of these interconnected production and financial linkages in the propagation of financial shocks. Empirically, I find, based on U.S. input-output matrix and loan data, that the upstream propagation of financial shocks is stronger than the downstream propagation. Theoretically, I elaborate a model that can capture this pattern of shocks, of which trade credit is an important component. Moreover, the model reflects the fact that trade credit attenuates the propagation of financial shocks when shocks are relatively small through the sharing of liquidity and amplifies their propagation when shocks are relatively large through illiquidity contagion. (Copyright: Elsevier)

Suggested Citation

  • Shaowen Luo, 2020. "Propagation of Financial Shocks in an Input-Output Economy with Trade and Financial Linkages of Firms," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 36, pages 246-269, April.
  • Handle: RePEc:red:issued:18-244
    DOI: 10.1016/j.red.2019.10.004
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    Citations

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    Cited by:

    1. Saki Bigio & Jennifer La’O, 2020. "Distortions in Production Networks," The Quarterly Journal of Economics, Oxford University Press, vol. 135(4), pages 2187-2253.
    2. Banu Demir & Beata Javorcik & Tomasz K. Michalski & Evren Ors, 2020. "Financial Constraints and propagation of shocks in production network," Discussion Papers 2020-23, University of Nottingham, GEP.
    3. Saki Bigio, 2013. "Financial Frictions in Production Networks," 2013 Meeting Papers 121, Society for Economic Dynamics.
    4. Hsuan-Li Su, 2019. "Financial Frictions, Capital Misallocation, and Input-Output Linkages," 2019 Meeting Papers 978, Society for Economic Dynamics.
    5. Engin L. Altinoglu, 2018. "The Origins of Aggregate Fluctuations in a Credit Network Economy," Finance and Economics Discussion Series 2018-031, Board of Governors of the Federal Reserve System (U.S.).
    6. Sophie Osotimehin & Latchezar Popov, 2020. "Misallocation and Intersectoral Linkages," Opportunity and Inclusive Growth Institute Working Papers 30, Federal Reserve Bank of Minneapolis.
    7. Levent Altinoglu, 2018. "The Origins of Aggregate Fluctuations in a Credit Network Economy," 2018 Meeting Papers 626, Society for Economic Dynamics.

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    More about this item

    Keywords

    Production network; Financial friction; Trade credit;
    All these keywords.

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • 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

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