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Consumption risk sharing over the business cycle: the role of small firms' access to credit markets

  • Mathias Hoffmann
  • Iryna Shcherbakova

Consumption risk sharing among U.S. federal states increases in booms and decreases in recessions. We find that small firms' access to financial markets plays an important role in explaining this stylized fact: business cycle fluctuations in aggregate risk sharing are more pronounced in states in which small firms account for a large share of output. In addition, better access of small firms to credit markets in the wake of state-level banking deregulation during the 1980s seems to have loosened the dependence of aggregate risk sharing on the business cycle. Not only do our result support that better access to credit markets may have made it easier for the owners of small firms to smooth income in the face of adverse cash-flows shocks to their business. They also suggest an additional welfare benefit from banking deregulation: access to financial markets has become more reliable and is more easily available when households and firms need it most urgently - in economic downturns. A possible implication of these findings is that the welfare costs of a monetary tightening could have been substantially reduced as a result of the financial liberalization at the state level.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 363.

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Date of creation: Mar 2008
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Handle: RePEc:zur:iewwpx:363
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