Credit Constraints, FirmsPrecautionary Investment, and the Business Cycle

This paper studies the macroeconomic implications of …rms’precautionary real investment behavior in response to the anticipation of future …nancing constraints. Firms increase their demand for liquid and safe but low-return investments in anticipation of future borrowing constraints in order to decrease the probability of having to forego future pro…table investment opportunities. I show in a calibrated model that this behavior is at the source of a novel and poweful ampli…cation and propagation channel of macroeconomic shocks. Furthermore, it can account for the observed business cycle patterns of the aggregate and …rm-level composition of real investment, a set of observations which is at odds with the existing models studying the macroeconomic implications of …nancial frictions, in which the expectation of future credit constraints does not directly a¤ect …rms’current actions. Keywords: Investment, Financial Frictions, Business Cycles, Idiosyncratic Production Risk JEL Classi…cation Numbers: D86, D92, E22, E32, G31, G32 I am grateful to Kosuke Aoki and Nobu Kiyotaki for very valuable discussions, and for very helpful comments Vicente Cunat, Wouter den Haan, Antoine Faure-Grimaud, Roman Inderst, Eric Leeper, Albert Marcet, Raoul Minetti, Alex Michaelides, Javier Suarez, David C. Webb, Alwyn Young and seminar participants in LSE, HEC Montreal, Indiana, CEMFI, Bank of Spain, Alicante, Carlos III, Autonoma de Barcelona, IAE-CSIC, Cambridge, Birkbeck, Bank of England, the Society for Computational Economics Meetings 2007 (Montreal), and the Econometric Society Summer Meetings 2007 (Duke).