Working Paper: NBER ID: w11349
Authors: Philippe Aghion; Georgemarios Angeletos; Abhijit Banerjee; Kalina Manova
Abstract: We examine how credit constraints affect the cyclical behavior of productivity-enhancing investment and thereby volatility and growth. We first develop a simple growth model where firms engage in two types of investment: a short-term one and a long-term productivity-enhancing one. Because it takes longer to complete, long-term investment has a relatively less procyclical return but also a higher liquidity risk. Under complete financial markets, long-term investment is countercyclical, thus mitigating volatility. But when firms face tight credit constraints, long-term investment turns procyclical, thus amplifying volatility. Tighter credit therefore leads to both higher aggregate volatility and lower mean growth for a given total investment rate. We next confront the model with a panel of countries over the period 1960-2000 and find that a lower degree of financial development predicts a higher sensitivity of both the composition of investment and mean growth to exogenous shocks, as well as a stronger negative effect of volatility on growth.
Keywords: credit constraints; productivity; investment; volatility; growth
JEL Codes: E22; E32; O16; O30; O41; O57
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tighter credit constraints (E51) | higher aggregate volatility (E19) |
| Tighter credit constraints (E51) | lower mean growth for a given total investment rate (O41) |
| Lower financial development (O16) | higher sensitivity of investment composition and mean growth to exogenous shocks (E22) |
| Tighter credit constraints (E51) | stronger negative effect of volatility on growth (F69) |
| Adverse price shocks (E31) | stronger negative growth impact in countries with tighter credit (F65) |
| Lower level of private credit (G21) | more sensitive composition of investment to shocks (E22) |
| Volatility (E32) | negative correlation with growth (O44) |
| Tighter credit constraints (E51) | more negative correlation between volatility and growth (O49) |