Understanding the Macroeconomic Effects of Working Capital in the United Kingdom

47 Pages Posted: 22 Apr 2011

See all articles by Emilio Fernández Corugedo

Emilio Fernández Corugedo

Bank of England

Michael F. McMahon

University of Warwick - Faculty of Social Studies; London School of Economics & Political Science (LSE)

Stephen Millard

Bank of England

Lukasz Rachel

Bank of England

Date Written: April 18, 2011

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.

Keywords: Working capital, business cycle model, spreads, financial crisis

JEL Classification: E20, E51, E52

Suggested Citation

Fernandez-Corugedo, Emilio and McMahon, Michael F. and Millard, Stephen and Rachel, Lukasz, Understanding the Macroeconomic Effects of Working Capital in the United Kingdom (April 18, 2011). Bank of England Working Paper No. 422, Available at SSRN: https://ssrn.com/abstract=1814987 or http://dx.doi.org/10.2139/ssrn.1814987

Emilio Fernandez-Corugedo

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Michael F. McMahon (Contact Author)

University of Warwick - Faculty of Social Studies ( email )

United Kingdom

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Stephen Millard

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Lukasz Rachel

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
218
Abstract Views
1,069
rank
156,470
PlumX Metrics