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Title: Financial Shocks and Investment Recovery in a Model of Customer Markets

Citation Type: Miscellaneous

Publication Year: 2016

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Abstract: The rapid improvement in financial conditions and the sluggish recovery of physical investment in the aftermath of the Great Recession are difficult to reconcile with the predictions of existing models that link impaired access to credit and investment. I propose a tractable model that solves this puzzle by exploiting the role of customer markets in shaping the persistent effects of financial shocks on investment decisions. In my model, firms react to a negative financial shock by reducing expenditures in sales-related activities and increasing prices to restore internal liquidity, at the expense of customer accumulation. Once financial conditions start reverting to normal levels, the firm postpones investment due to a shortage of customers relative to its existing production capacity and the need to first rebuild its customer base. This mechanism can capture two important features of the data: First, the slow recovery of investment despite improving financial conditions, and second, the positive correlation between financial conditions and investment observed during downturns and the weakening of this correlation observed during upturns.

Url: http://econweb.umd.edu/~leon/JMP_JLeon.pdf

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Authors: Leon-Diaz, John J

Publisher: University of Maryland

Data Collections: IPUMS CPS

Topics: Other

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