The Marginal Propensity to Hire

69 Pages Posted: 18 Dec 2018

See all articles by Davide Melcangi

Davide Melcangi

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: December 2018

Abstract

This paper studies the link between firm-level financial constraints and employment decisions, as well as the implications for the propagation of aggregate shocks. I exploit the idea that, when the financial constraint binds, a firm adjusts its employment in response to cash flow shocks. I identify such shocks from changes to business rates, a U.K. tax based on a periodically estimated value of the property occupied by the firm. A 2010 revaluation implied that similar firms, occupying similar properties in narrowly defined geographical locations, experienced different tax changes, allowing me to control for confounding shocks to local demand. I find that, on average, for every £1 of additional cash flow, 39 pence are spent on employment. I label this response the marginal propensity to hire (MPH). I then calibrate a firm dynamics model with financial frictions toward this empirical evidence. As in the data, small and leveraged firms in the model have a greater MPH. Simulating a tightening of credit conditions, I find that the model can account for much of the decline in U.K. aggregate output and employment observed in the wake of the financial crisis.

Keywords: financial frictions, employment, heterogeneous firms

JEL Classification: E24, E44, G01, G32

Suggested Citation

Melcangi, Davide, The Marginal Propensity to Hire (December 2018). FRB of New York Staff Report No. 875, Available at SSRN: https://ssrn.com/abstract=3302845 or http://dx.doi.org/10.2139/ssrn.3302845

Davide Melcangi (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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