Finance-thy-Neighbor. Trade Credit Origins of Aggregate Fluctuations

Margit Reischer
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Margit Reischer: Cambridge University

No 1129, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: Trade credit in the form of a delay of inputs payments is an important source of financing for all types of firms. In this paper, I study the role of credit linkages for the propagation of financial shocks in a production network where firms finance their working capital requirements using bank and trade credit. To this end, I build a quantitative multisector model with endogenous credit linkages between representative firms in each sector. The endogenous adjustment in the volume and cost of trade credit captures two counteracting mechanisms: (1) Firms smooth interest rate shocks by substituting bank and supplier finance. (2) An increase in the interest rate that a firm charges on trade credit tightens the financing terms of its customers thereby amplifying financial shocks. Quantitatively, the model accounts for 30% of the variation in aggregate output in the US-economy. Model simulations show that the existence of the trade credit network doubled the drop in aggregate output during the 2008-2009 crisis relative to an equivalent economy with bank-finance only. Furthermore, the ratio of total outstanding payments owed by customers for already delivered goods and services to bank credit is a good proxy for the systemic importance of a sector in propagating liquidity shocks.

Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:1129

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