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Did Smaller Firms face Higher Costs of Credit during the Great Recession? A Vector Error Correction Analysis with Structural Breaks

Author

Listed:
  • Louisa Kammerer
  • Miguel D. Ramirez

    (Department of Economics, Trinity College)

Abstract

This paper examines the challenges firms(and policymakers) encounter when confronted by a recession at the zero lower bound, when traditional monetary policy is ineffective in the face of deteriorated balance sheets and high costs of credit. Within the larger body of literature, this paper focuses on the cost of credit during a recession, which constrains smaller firms from borrowing and investing, thus magnifying the contraction. Extending and revising a model originally developed by Walker (2010) and estimated by Pandey and Ramirez (2012), this study uses a Vector Error Correction Model with structural breaks to analyze the effects of relevant economic and financial factors on the cost of credit intermediation for small and large firms. Specifically, it tests whether large firms have advantageous access to credit, especially during recessions. The findings suggest that during the Great Recession of 2007-09 the cost of credit rose for small firms while it decreased for large firms, ceteris paribus. From the results, the paper assesses alternative ways in which the central bank can respond to a recession facing the zero lower bound.

Suggested Citation

  • Louisa Kammerer & Miguel D. Ramirez, 2018. "Did Smaller Firms face Higher Costs of Credit during the Great Recession? A Vector Error Correction Analysis with Structural Breaks," Working Papers 1707, Trinity College, Department of Economics, revised Jun 2018.
    • Handle: RePEc:tri:wpaper:1707
    as

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    References listed on IDEAS

    as
    1. Krugman, Paul, 2000. "Thinking About the Liquidity Trap," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 221-237, December.
    2. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
    3. Michael T. Kiley & John M. Roberts, 2017. "Monetary Policy in a Low Interest Rate World," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 48(1 (Spring), pages 317-396.
    4. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    5. Frederic S. Mishkin, 2011. "Monetary Policy Strategy: Lessons from the Crisis," NBER Working Papers 16755, National Bureau of Economic Research, Inc.
    6. Dolado, Juan J & Jenkinson, Tim & Sosvilla-Rivero, Simon, 1990. "Cointegration and Unit Roots," Journal of Economic Surveys, Wiley Blackwell, vol. 4(3), pages 249-273.
    7. Walker, David A., 2010. "Costs of short-term credit for small and large firms," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(4), pages 485-491, November.
    8. Carmen M. Reinhart & Vincent Reinhart, 2010. "After the fall," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 17-60.
    9. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
    10. Miguel Ramirez & Aalok Pandey, 2012. "Why does the Cost of Credit Intermediation Increase for Small Firms Relative to Large Firms during Recessions? A Conceptual and Empirical Analysis," Working Papers 1205, Trinity College, Department of Economics.
    11. Clouse James & Henderson Dale & Orphanides Athanasios & Small David H. & Tinsley P.A., 2003. "Monetary Policy When the Nominal Short-Term Interest Rate is Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-65, September.
    12. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Cost of credit; General impulse response functions; Granger causality test; Great Recession; Gregory Hansen single-break cointegration test; Johansen cointegration test; KPSS unit root test; Monetary policy; Vector error correction model (VECM); Small and large firms; and Zero lower bound (ZLB).;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G01 - Financial Economics - - General - - - Financial Crises

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