Credit Constraints, Firms' Precautionary Investment, and the Business Cycle

36 Pages Posted: 17 Feb 2009 Last revised: 20 Oct 2016

Date Written: February 16, 2016

Abstract

Credit constrained firms prefer types of capital that generate significant pledgeable output and are liquid, since they loosen current and future credit constraints. Because pledgeability and liquidity are low for long-term firm-specific capital, a negative temporary aggregate productivity shock that tightens credit constraints creates a bias towards liquid short-term investments. This dampens the short-run negative output reaction to the shock, at the expense of strong medium-run propagation effects. This mechanism can create a short-run expansion when a future tightening in credit conditions is anticipated.

Keywords: Investment types; Financial frictions; Business cycles; Idiosyncratic risk; Firm heterogeneity

JEL Classification: D92, E22, E32, E44, G31, G32

Suggested Citation

Perez-Orive, Ander, Credit Constraints, Firms' Precautionary Investment, and the Business Cycle (February 16, 2016). Journal of Monetary Economics, Vol. 78, No. April, 2016. Available at SSRN: https://ssrn.com/abstract=1344581 or http://dx.doi.org/10.2139/ssrn.1344581

Ander Perez-Orive (Contact Author)

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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