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Credit constraints, firms' precautionary investment and the business cycle

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    This 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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    File URL: https://econ-papers.upf.edu/papers/1237.pdf
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    Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1237.

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    Date of creation: Sep 2010
    Date of revision: Nov 2012
    Handle: RePEc:upf:upfgen:1237
    Contact details of provider: Web page: http://www.econ.upf.edu/

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    1. Angeletos, George-Marios & Calvet, Laurent-Emmanuel, 2006. "Idiosyncratic production risk, growth and the business cycle," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1095-1115, September.
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    8. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
    9. Ruediger Bachmann & Ricardo J. Caballero & Eduardo Engel, 2008. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," Cowles Foundation Discussion Papers 1566R, Cowles Foundation for Research in Economics, Yale University, revised Apr 2010.
    10. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
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    13. Marinescu, Ioana & Klemm, Alexander & Bond, Stephen & Aghion, Philippe, 2004. "Technology and Financial Structure: Are Innovative Firms Different?," Scholarly Articles 3200323, Harvard University Department of Economics.
    14. Christiano, Lawrence & Rostagno, Massimo & Motto, Roberto, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
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    16. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
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