Working Paper: NBER ID: w2758
Authors: Mark Gertler; R Glenn Hubbard
Abstract: Recent research in macroeconomics -- both theoretical and empirical -- has resurrected the idea that capital market imperfections may be significant factors in business volatility by making new progress in characterizing the mechanisms. This paper outlines a case for a financial aspect to business fluctuations, in light of the contributions of this new literature. We present a theoretical model that explicitly motivates how financial factors may affect investment. We then report some existing tests of the model's basic predictions4 and also present two new sets of results. The first demonstrates that the inverse relation between sales variability and size documented in many studies may be due to financial rather than technological factors, in contrast to the conventional view. The second lends support to a theoretical prediction of the model. that the effects of capital market frictions on investment should be asymmetric -- having more impact in recessions than booms. The final section presents conclusions, and addresses some policy questions.
Keywords: financial market imperfections; business fluctuations; investment volatility; capital market frictions; economic downturns
JEL Codes: E32; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital market imperfections (G19) | business fluctuations (E32) |
| capital market frictions (G19) | investment behavior (G11) |
| sales variability (C29) | firm size (L25) |
| firm size (L25) | vulnerability to financial shocks (F65) |
| capital market frictions (G19) | investment during recessions (E22) |
| cost of external financing (G32) | investment (G31) |
| internal net worth (G19) | investment decisions (G11) |