Saleem Bahaj, Angus Foulis, Gabor Pinter and Paolo Surico
Changes in interest rates affect different parts of the economy differently. In this post, building on a recent working paper, we consider how different types of firms respond to interest rate changes. We focus on firm level employment and ask which firms do the most hiring and firing when monetary policy adjusts. For instance, how important is the age of the firm, its balance sheet position or its size in determining the firm level response to interest rates? Furthermore, do these patterns of responses tell us something about how monetary policy affects the economy?
Apocalypse Now is widely regarded as a masterpiece of the new Hollywood era. Director Francis Ford Coppola displayed audacious vision and a willingness to take risks. But we don’t just mean artistic risk. Mr Coppola gambled financially too: he staked his Napa Valley house and vineyard on the film, pledging it order to get the $32 million in loans necessary to keep the production on the road. While his movie was exceptional, there is nothing unusual about Mr Coppola’s financial strategy. Small business owners worldwide use their personal assets, and often their house, to back loans to their firms: in a new paper, we use microdata for several thousand firms to show how important this can be for UK investment.
Since the financial crisis the UK has experienced a period of weak productivity growth, weak investment coupled with a decline in credit to non-financial sectors of the economy. But there is debate about the direction of causality: did low growth and other structural factors mean firms and households wanted to borrow less – as argued by Martin Wolf? Or did the financial sector offer too few funds to the real economy in the wake of the crisis as banks tried to repair their balance sheets. Alternatively, the financial system may not be functioning properly in general, if much of the financial sector’s activity contributes little to the betterment of lives and efficiency of business – a point made by John Kay.
Following the financial crisis, net corporate financing has exhibited a similar overall pattern in the UK and the US. But the composition of that financing has been very different – with the net debt stock of UK non-financial corporates falling by more than 20% of nominal GDP. By contrast, in the US the fall was only 10%, and around half of this has since been regained. Why did the two countries’ experiences diverge so much after the crisis? In this post, I argue that the root cause of this divergence was a fall in UK corporates’ demand for debt, rather than a hit to credit supply. Business cycles, and credit conditions appear to be similar in both countries, but in the UK there has been lower demand for corporate gearing from firms, a weaker recovery in M&A activity, and fewer share buybacks than in the US.
UK private non-financial corporations (PNFCs) consistently ran a financial surplus between 2002 and 2013. They now hold around £1.8 trillion of financial assets, including £0.5 trillion of cash. This has attracted attention from policymakers and the media. Should we expect companies to spend these assets to finance investment? The MPC considers this to be possible (see e.g. the February 2015 Inflation Report). Many agree, calling on companies to spend their ‘cash hoards’ (see e.g. these articles in the Telegraph and the FT). Here, we explain why we think companies are unlikely to run down their assets significantly. This does not mean that they will not invest; rather, they will not necessarily finance investment through liquidating assets.