Firms’ Precautionary Savings and Employment during a Credit Crisis

Abstract: Can the macroeconomic effects of credit supply shocks be large even when a small share of firms are credit-constrained? I use U.K. firm-level accounting data to discipline a heterogeneous-firm model where the interaction between real and financial frictions induces precautionary cash holdings. In the data, firms increased their cash ratios during the last recession, and cash-intensive firms displayed higher employment growth. A tightening of firms’ credit conditions generates the same dynamics in the model. Unconstrained firms pre-emptively respond to credit supply shocks; this precautionary channel, when appropriately quantified, crucially matters for the aggregate dynamics and firm-level patterns.

Keywords: financial frictions; employment; heterogeneous firms; precautionary savings;

JEL Classification: E44; G01; G32; L25;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2019-11-01

Number: 904

Note: Revised July 2021.