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Understanding the macroeconomic effects of working capital in the United Kingdom

Author

Listed:
  • Emilio Fernandez-Corugedo

    (Bank of England)

  • Michael McMahon

    (University of Warwick, and Centre for Economic Performance, LSE)

  • Stephen Millard

    (Bank of England)

  • Lukasz Rachel

    (Bank of England)

Abstract

The most recent recession has been associated with a financial crisis that led to a large widening of spreads and quantitative restrictions on lending. As well as affecting investment, such a credit contraction is likely to have had a large effect on the working capital positions of UK firms and this, in turn, is likely to have affected the United Kingdom’s supply potential, at least temporarily. However, the role of such disruptions in the business cycle is not well understood. In this paper we first document the behaviour of working capital in the United Kingdom. In order to understand the effects of working capital on macroeconomic variables, we then solve and calibrate a DSGE model that introduces an explicit role for the components of working capital (net cash, inventories, and trade credit). We find that this model produces the standard responses of macroeconomic variables to productivity shocks, but we also find that financial intermediation shocks, similar to those experienced in the United Kingdom post-2007, have persistent negative effects on economic activity; these effects are reinforced by reductions in trade credit. Our model also documents a crucial role for monetary policy to offset such shocks.

Suggested Citation

  • Emilio Fernandez-Corugedo & Michael McMahon & Stephen Millard & Lukasz Rachel, 2011. "Understanding the macroeconomic effects of working capital in the United Kingdom," Bank of England working papers 422, Bank of England.
  • Handle: RePEc:boe:boeewp:0422
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    References listed on IDEAS

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    Citations

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    Cited by:

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    2. Marcin Bielecki, 2022. "Long Shadows of Financial Shocks: An Endogenous Growth Perspective," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 3, pages 1-23.
    3. Tayler, William J. & Zilberman, Roy, 2016. "Macroprudential regulation, credit spreads and the role of monetary policy," Journal of Financial Stability, Elsevier, vol. 26(C), pages 144-158.
    4. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
    5. Martha Coleman & Justice Mark Baidoo, 2020. "The Interaction of Financial Leverage and Firm's Operational Efficiency," Business and Economic Research, Macrothink Institute, vol. 10(1), pages 235-250, March.
    6. Xakousti Chrysanthopoulou & Nikolaos Mylonidis & Moise Sidiropoulos, 2025. "Regulatory Capital Requirements, Inflation Targeting, and Equilibrium Determinacy," Open Economies Review, Springer, vol. 36(1), pages 63-104, February.
    7. Davide Melcangi, 2024. "Firms' Precautionary Savings and Employment during a Credit Crisis," American Economic Journal: Macroeconomics, American Economic Association, vol. 16(1), pages 356-386, January.
    8. Agénor, Pierre-Richard & Pereira da Silva, Luiz A., 2014. "Macroprudential regulation and the monetary transmission mechanism," Journal of Financial Stability, Elsevier, vol. 13(C), pages 44-63.
    9. Mr. Thorvardur Tjoervi Olafsson, 2018. "Cross-Border Credit Intermediation and Domestic Liquidity Provision in a Small Open Economy," IMF Working Papers 2018/202, International Monetary Fund.
    10. Stephen Millard & Alexandra Varadi & Eran Yashiv, 2018. "Shock transmission and the interaction of financial and hiring frictions," Bank of England working papers 769, Bank of England.
    11. Tayler, William & Zilberman, Roy, 2014. "Macroprudential Regulation and the Role of Monetary Policy," Dynare Working Papers 37, CEPREMAP.
    12. Enqvist, Julius & Graham, Michael & Nikkinen, Jussi, 2014. "The impact of working capital management on firm profitability in different business cycles: Evidence from Finland," Research in International Business and Finance, Elsevier, vol. 32(C), pages 36-49.
    13. Kapetanios, George & Price, Simon & Young, Garry, 2018. "A UK financial conditions index using targeted data reduction: Forecasting and structural identification," Econometrics and Statistics, Elsevier, vol. 7(C), pages 1-17.
    14. Stephen Burgess & Emilio Fernandez-Corugedo & Charlotta Groth & Richard Harrison & Francesca Monti & Konstantinos Theodoridis & Matt Waldron, 2013. "The Bank of England's forecasting platform: COMPASS, MAPS, EASE and the suite of models," Bank of England working papers 471, Bank of England.
    15. Alina Barnett & Sandra Batten & Adrian Chiu & Jeremy Franklin & Maria Sebastia-Barriel, 2014. "The UK productivity puzzle," Bank of England Quarterly Bulletin, Bank of England, vol. 54(2), pages 114-128.
    16. Mahmoudzadeh, Amineh & Nili, Masoud & Nili, Farhad, 2018. "Real effects of working capital shocks: Theory and evidence from micro data," The Quarterly Review of Economics and Finance, Elsevier, vol. 67(C), pages 191-218.

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    More about this item

    Keywords

    Working capital; business cycle model; spreads; financial crisis.;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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