Wednesday, September 11, 2013

stig greenwald on rationing credit

Several points should be made about the nature of aggregate (and individual

firm) investment behavior implicit in equations (4) and (5). First, high profitability

in any given period, by generating increases in firm equity levels (for

non-credit-constrained firms) and increased cash flow (for credit-constrained

firms), will lead to increased future investment. Thus, the model suggests the

kind of significant relationship between current operating cash flow and investment

found by Hubbard, Fazzari, and Petersen (1988), among others.

Also, if high profitability in any period is related to increases in demand in

that period, the model will exhibit the kind of accelerator behavior that has

been so successful in explaining actual investment behavior.18 The model can

be usefully thought of, therefore, as providing a microeconomic rationale for

both the cash flow and accelerator aspects of investment behavior that appear

to play such a significant role in practice.19 Second, firms wishing to borrow

pay firm-specific rates of interest, not some average rate on all assets. With

imperfectly informed lenders, changes in general market rates do not necessarily

lead to changes in the rates charged to borrowing firms.20 Some part of

the shift in loan supply is absorbed by increased credit rationing since charging

higher interest rates has an adverse effect on the quality and riskiness of

the borrower pool (see below). Thus, the rate, rt (and the associated expected

return to lenders ft), which enters the investment model above may vary significantly

less than widely observed market rates (such as Treasury-bill rates),

which would be available for use in any empirically estimated investment

equation. Second, the impact of interest rates tends to be small relative to the

impact of changes in a firm's financial position,21 and real interest-rate series

have, until the very recent past, been observably quite stable. Thus, the variability

in the financial positions of firms and the perceived riskiness of the

environment they face over the business cycle can be responsible for a far

greater share of the variation in investment over time than market interest

rates. For both reasons, the model provides an explanation for the relatively

small and elusive role that interest rates play in empirical investment equations

and suggests that interest rates themselves do not play a primary role in

macroeconomic stabilization.22

Finally, as will be noted extensively in later sections of this paper, investment,

although defined for explanatory purposes as investment in physical

capital of the usual sort, need not and should not be interpreted so narrowly.

Part of investment takes the form of working capital and the hiring and training

of workers, and a rise in the cost of investment (because, e.g., of a deterioration

in a firm's equity position) will be reflected as a reduction in working

capital, in