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Firms’ precautionary savings and employment during a credit crisis

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  • Melcangi, Davide

Abstract

Can the macroeconomic effects of credit supply shocks be large even in an economy in which the share of credit-constrained firms is small? I address this question using a model with firm heterogeneity, in which the interaction between real and financial frictions gives rise to precautionary cash holdings. Using UK firm-level balance sheet data, I show that firms hoarded cash relative to their assets during the last recession, and cash-intensive firms cut their workforces by less. A quantitative version of the model, disciplined by these data, generates similar dynamics in response to a tightening of firms’ credit conditions. The simulated economy experiences a sizeable fall in aggregate employment and prolonged substitution from capital to cash. Most of the aggregate dynamics are driven by unconstrained firms, pre-emptively responding to changes in credit conditions, in anticipation of future idiosyncratic productivity shocks. The model’s ability to generate predictions in line with the data crucially relies on this precautionary channel.

Suggested Citation

  • Melcangi, Davide, 2016. "Firms’ precautionary savings and employment during a credit crisis," LSE Research Online Documents on Economics 86237, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:86237
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    File URL: http://eprints.lse.ac.uk/86237/
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    Cited by:

    1. Gabriel Chodorow‐Reich & Antonio Falato, 2022. "The Loan Covenant Channel: How Bank Health Transmits to the Real Economy," Journal of Finance, American Finance Association, vol. 77(1), pages 85-128, February.
    2. Boeri, Tito & Garibaldi, Pietro & Moen, Espen R., 2018. "Financial constraints in search equilibrium: Mortensen Pissarides meet Holmstrom and Tirole," Labour Economics, Elsevier, vol. 50(C), pages 144-155.

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    More about this item

    Keywords

    financial frictions; precautionary savings; employment; heterogeneous firms;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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