Understanding the Credit Multiplier: The Working Capital Channel
60 Pages Posted: 16 Nov 2017 Last revised: 21 Oct 2018
Date Written: October 3, 2018
We provide novel evidence that frictions in the financing of working capital can limit firms’ production capacity, leading to the amplification and propagation of liquidity problems over time. We propose a new approach to identify this firm credit multiplier that compares how a same firm responds to permanent shocks differently when these shocks are initiated in the period in which they are predicted to be most profitable (their “main quarter”). Our analysis implements this test with oil price shocks and provides extensive evidence supporting our identification strategy. Our results suggest that the financing of working capital can be an important channel for understanding the real effects and determinants of short-term funding problems faced by firms.
Keywords: Credit Multiplier, Working Capital, Financing Frictions
JEL Classification: G31, G32, G38, E32
Suggested Citation: Suggested Citation