Working Capital, Trade and Macro Fluctuations

Transcription

1 Working Capital, Trade and Macro Fluctuations Se-Jik Kim SeoulNationalUniversity Hyun Song Shin Princeton University May 2013

2 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 1 Working Capital Stylized corporate balance sheet Assets Cash Inventories Receivables Long-term assets Liabilities Equity Short term debt Payables Long-term liabilities (Net) working capital = Inventories + Receivables Payables

3 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 2 Time Dimension of Production date 1 date 2 Assets Cash Inventories (1 period old) (= v ) Inventories (2 periods old) (=2v ) Equity Liabilities date 3 3v 2v v Inventories (3 periods old) (=3v ) Short-term Debt Stage 3 Stage 2 Stage 1 Receivables Long-term Assets Payables Long-term Liabilities Figure 1. Date 3 balance sheet of firm with three production stages. greater inputs and hence greater financing needs Older vintages of inventories reflect

4 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 3 Boundary of the Firm When the production chain crosses the boundary of the firm, working capital needs are reflected in receivables and payables Inventories are known to be procyclical Receivables and payables are also procyclical and reflect financial conditions

5 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 4 Billion Dollars Nonfinancial corporate business; trade payables; liability 200 Nonfinancial corporate business; trade receivables; asset Nonfinancial corporate business; inventories excluding IVA, current cost basis Figure 2. Trade receivables, trade payables and inventories of the US non-financial corporate business sector (Source: Federal Reserve Flow of Funds, Table F102)

6 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 5 Treasury and Baa Corporate Rates 13.0 Percent Jan-10 Jul-08 Jan-07 Jul-05 Jan-04 Jul-02 Jan-01 Jul-99 Jan-98 Jul-96 Jan-95 Jul-93 Jan-92 Jul-90 Jan-89 Jul-87 Jan yr Treasury constant Maturity rate Baa Rate

7 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 6 Treasury and Baa Spread 7.0 Baa-10 yr Treasury Spread 6.0 Percent Jan-10 Jul-08 Jan-07 Jul-05 Jan-04 Jul-02 Jan-01 Jul-99 Jan-98 Jul-96 Jan-95 Jul-93 Jan-92 Jul-90 Jan-89 Jul-87 Jan-86

8 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 7 Panel regressions with firm fixed effects (1) (2) (3) Dependent variable dln(receivables) dln(inventory) dln(payables) dln(sales) *** *** *** (87.76) (62.69) (53.12) dln(bd leverage) *** *** * (3.04) (2.91) (1.94) constant ** *** (-0.0) (2.14) (29.89) Observations Firms R-squared (Compustat US manufacturing firms, ) dln(bd leverage) = annual log difference of US broker dealer leverage Clustered standard errors at firm level, t-statistic in parantheses

9 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations mfg sales / value-added mfg sales/va mfg va/gdp mfg value-added/gdp Figure 3. US manufacturing sales to value-added ratio and the ratio of manufacturing value-added to GDP (Source: US Census Bureau)

10 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 10 Outline Model of production chain without offshoring (no financial sector) Model of production chain due to offshoring (no financial sector) Close the model with financial sector

11 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 11 Production Chain without Offshoring No fixed capital No savings decision No labor supply decision No distortions to product or labor markets Only friction on real side of economy is that production takes time Financial shocks impact output and productivity through cost of working capital

12 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 12 Time and Working Capital Production stages cumulative cashflow date 1. (1 2) ( +1) +1. ( ).... Wage cost cannot be deferred (workers cannot be lenders to firm) Cash transfer upstream is instantaneous Constant hazard rate of chain s failure after date +1

13 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 13 Lender Cash Flow as Function of rwn n 1 / 2 rwn n 1 / 2 n n t nw n w Figure 4. Lender cash flow as function of

14 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 14 Model workers/firms Chain length Number of chains = Output per chain (of length ) = ( ) Output per firm (= output per worker) ( ) = (0 1)

15 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 15 An Austrian Theme Roundabout production and the temporal dimension of production [t]he indirect method entails a sacrifice of time but gains the advantage of an increase in the quantity of the product. Successive prolongations of the roundabout method of production yield further quantitative increases though in diminishing proportion. [Böhm-Bawerk (1884) Capital and Interest]

16 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 16 Aggregate Credit Demand Firms finance working capital (inventories and net accounts receivable) with credit Aggregate credit demand: = 1 2 ( +1) = +1 2

17 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 17 Joint Profit Maximization Abstract from incentive/bargaining within the chain Solution as upper bound to joint payoffs with incentive problems Ex ante, choose to maximize X = +1 (1 ) ( ) Equivalently, maximize per-period profit Π = ³ = 1+ ( +1) 2

18 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 18 First-order condition: = determined by zero profit condition: ³ = µ ( +1) 2

19 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 19 = µ 1 µ 1+ 2 = 1 µ µ 1+ 2 ( ) ( ) ³ =2 µ 1 1 ( ) 2+ = µ µ 1+ 2 ( ) 1 = ( )

20 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 20 Ratio of Sales to Value-Added = sale by firm = + 1 = + ( 1) +. 1 = = (1 + ) 1 = 2 (1 + ). 1 = (1 + ) ( ( 1))

21 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 21 Sales to value-added ratio: P =1 1 =( +1) ( +2 )( + (1 + )+3) = 3 (1 )( +2) SVA r Figure 5. Sales to value-adde ratio ( =0 033)

22 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations mfg sales / value-added mfg sales/va mfg va/gdp mfg value-added/gdp Figure 6. US manufacturing sales to value-added ratio and the ratio of manufacturing value-added to GDP (Source: US Census Bureau)

23 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 23 Productivity Y/L r

24 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 24 Wage w r

25 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 25 Credit Demand K/L r

26 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 26 Working Capital and Fixed Capital Analogy ( ) = µ 2 = 1 µ 2 = 1 If working capital (e.g. inventories) is treated as factor of production (Ramey (1989)), then TFP term has endogenous variables.

27 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 27 Working Capital and Fixed Capital Analogy ( ) = µ 2 1 Plot of TFP term in production function for =0 033 TFP r

28 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 28 Three Approaches to Trade Technological Spatial Temporal Temporal dimension implies role for financial conditions

29 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 29 Before Offshoring After Offshoring transport stage date 1 date 2 date 1 date 3 date 2 date 4 cash date 3 cash date 5 Stage 1 Stage 2 Stage 3 Stage 1 Stage 2 Stage 3 Figure 7. Left hand panel illustrates the inventories needed in a three-stage production process. hand panel illustrates increased inventories from offshoring the second stage. The right

30 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 30 Offshoring entails greater working capital need Assets Liabilities Assets Liabilities Cash Equity Cash Equity Inventories (1 period old) x 1 Inventories (1 period old) x 1 Inventories (2 periods old) x 2 Inventories (outward bound) x 2 Short-term Debt Inventories (3 periods old) x 3 Inventories (3 periods old) x 3 Receivables Payables Short-term Debt Long-term Assets Long-term Liabilities Inventories (inward bound) x 4 Inventories (5 periods old) x 5 Receivables Long-term Assets Payables Long-term Liabilities

31 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 31 Inventories are not buffer stock When our grandfathers owned shops, inventory was what was in the back room. Now it is a box two hours away on a package car, or it might be hundreds more crossing the country by rail or jet, and you have thousands more crossing the ocean [Chief Executive Officer of UPS quoted in Thomas Friedman, The World is Flat]

32 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 32 On-shoring or Re-shoring Figure 8. Cover page from Accenture (2011) Manufacturing s Secret Shift: Gaining Competitive Advantage by Getting Closer to the Customer

33 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 33 On-shoring or Re-shoring Companies are beginning to realize that having offshored much of their manufacturing and supply operations away from their demand locations, they hurt their ability to meet their customers expectations across a wide spectrum of areas, such as being able to rapidly meet increasing customer desires for unique products, continuing to maintain rapid delivery/response times, as well as maintaining low inventories and competitive total costs. [Accenture (2011) Manufacturing s Secret Shift: Gaining Competitive Advantage by Getting Closer to the Customer]

34 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 34 Production Chain due to Offshoring stages to the production chain and locations Multinational firms with operations in all locaitons Each location has absolute advantage in precisely one stage of the production Output of multinational firm (=production chain) is à X! =1 (0 1) with = ½ 1+ if stage is at high productivity location 1 otherwise

35 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 35 Output to offshoring stages of the production chain to location with absolute advantage Offshoring entails ( ) =( + ) wage cost time cost of 1 period added to production time If offshoring takes place times, the production process takes + periods.

36 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 36 World credit demand is = 1 2 ( + )( + +1) ( + ) = Profit of multinational firm is Π = ( + ) µ = ( + ) ( + +1) 1+ 2 is the proportion of the world workforce employed by firm

37 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 37 Firm s Offshoring Decision Optimal offshoring is = 1 µ µ Wage rate determined by zero profit condition = 2 Ã (1 1 )! 1 Trade volumes, output and productivity decline with financing cost

38 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 38 Value of International Trade Total sales (as 0) = 1 6 ( (1 + 2( + )) + 3) ( + +1) Value of international trade is = ( + ) Ã 1 ( + +1) 3 = +! 2 3 ( + ) +1 ( + ) +( + ) +2 Ratio of trade to output is declining in risk premium

39 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 39 Two Sector Model Two sectors. Sector 1 is =0. 0. Sector 2 benefits more from offshoring as its is Price for the output of Sector 2 in terms of sector 1 good Take first-order condition for 1 and 2 and impose zero profit condition for both sectors Labor takes all the surplus Labor is fully mobile, so that single wage rate applies to both sectors

40 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 40 From zero profit conditions for the two sectors, = = 1+ 2 (1 + ) (sector 1) (1) ( + 2 ) 1+ 2 (1 + )+ 2 (sector 2) 2 Then = (2 + (1 + )) µ + 1 µ (1 1 1 )

41 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 41 Proposition. decreasing in Productivity of sector 2 (value of output per worker) is à 2 = µ! 1 2 +(1+ )

42 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 42 Global Output Cobb-Douglas preferences ( 1 2 )= ln 1 +(1 )ln 2 Relative value of output of the two sectors is Then = 1 2 = 1 = (1 ) 1 2 +(1 ) (1 ) 1

43 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 43 Global output is: = (1 ) 1 Since 2 is decreasing in, wehave Proposition. Global output is declining in risk premium.

44 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 44 Trade Growth Accounting Notation: GDP Domestic manufacturing value-added Domestic manufacturing sales Imports Suppose that µ = µ = imported intermediate goods imported intermediate goods + domestically produced intermediate goods

45 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 45 Offshoring measure defined as: imported intermediate goods imported intermediate goods + domestically produced intermediate goods Then = =

46 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 46 So, import/gdp ratio is = Growth of offshoring can be obtained as ( ) = µ µ µ In long hand Offshoring growth = Growth of Imports/GDP Growth of mfg sales/value-added Growth of mfg/gdp

47 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations mfg value-added/gdp mfg sales/va mfg va/gdp 2.7 mfg sales / value-added Figure 9. US manufacturing sales to value-added and share of manufacturing in GDP

48 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations Annual Growth Rate of Offshoring and Import/GDP Imports/GDP q mfg sales/va mfg va/gdp Figure 10. Annual growth rates of offshoring, imports/gdp, manufacturing sales to value-added and share of manufacturing in GDP

49 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 49 Closing the Model with Credit Supply Banks provide credit. Each chain defaults with probability. Loans rolled over every period. Correlated defaults across chains, but bank can diversify away idiosyncratic risk (Vasicek (2002) credit risk model) Chain repays when ˆ 0, whereφ ( ) is standard normal cdf ˆ = Φ 1 ( )+ + p 1 ³ Pr ˆ 0 p = Pr³ + 1 Φ 1 ( ) = Φ Φ 1 ( ) =

50 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 50 Notation for Bank Balance Sheet Bank E 1 r C L 1 f

51 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 51 Bank diversifies away idiosyncractic risk Conditional on, defaults are independent. Diversify across many borrowers and eliminate idiosyncratic risk. value of assets is function of only ( ) (1 + ) Pr ³ ˆ 0 ³ p = (1+ ) Pr + 1 Φ 1 ( ) ³ Φ 1 ( ) = (1+ ) Φ 1 Realized (*)

52 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 52 density over realized assets ρ = 0.3 ε = 0.3 ε = 0.2 ε = z density over realized assets ε = 0.2 ρ = 0.3 ρ = 0.01 ρ = z Figure 11. The two charts plot the densities over realized assets when (1 + ) =1. The left hand charts plots the density over asset realizations of the bank when =0 1 and isvariedfrom0.1to0.3. The right hand chart plots the asset realization density when =0 2 and varies from 0.01 to 0.3.

53 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 53 Contracting Problem between Bank and Depositors Bank chooses portfolio of loans between: Good portfolio has probability of default 0, =0. distribution (normalized) is Outcome ( ) = ½ 0 if 1 1 if 1 (2) Bad portfolio has probability of default +,with 0,and = 0. Outcome distribution is ( ) =Φ ³ Φ 1 ( + )+ 1 Φ 1 ( ) (3)

54 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 54 Bank default point Define =(1+ ) (1 + ). is (1) (normalized) notional debt of bank and (2) strike price of embedded put option from limited liability (Merton (1974)) Bank chooses to maximize marked-to-market equity (ˆ ) [ ( )] subject to IC constraint: (ˆ ) [ ( )] (ˆ ) [ ( )] (4) Lemma 1. There is a unique solution,where 1. Corollary 2. Bank borrows at the risk-free rate

55 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 55 State price density is second derivative of the option price with respect to its strike price (Breeden and Litzenberger (1978)). Given risk-neutrality, ( ) = Z 0 [ ( ) ( )] or ( ) = R 0 1 R 0 ( ) ( ) if 1 R 1 [1 ( )] if 1 (5)

56 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 56 Thus ( ) is single-peaked, reaching its maximum at =1. Z 1 0 [ ( ) ( )] = Z 1 0 [1 ( )] Z 1 0 [1 ( )] = (ˆ ) (ˆ ) = (6) so ( ) approaches from above as 1. 1 for any bank with positive notional equity. So, we have a unique solution to ( ) = where the solution is in the range where ( ) is increasing. Therefore 1.

57 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 57 Supply of Credit by Bank Credit supply obtained from =(1+ ) (1 + ) and balance sheet identity = + = Funding rate is risk-free rate Lending rate determined as equilibrium in credit market =

58 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 58 Main Result Proposition. Tighter bank credit conditions result in (1) an increase in the borrowing rate (2) fall in output (3) fall in productivity per worker (4) fall in the wage (5) fall in the offshoring activity of firms. Corollary. Tighter credit conditions result in decline in trade volumes. Decline is larger with more advanced vertical specialization. (Bems, Johnson and Yi (2011))

59 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 59 Avenues for Future Research (1) Quantitative effects Finance is statistically significant, but not economically significant Need more sophisticated model for quantitative predictions Spreads do the damage, even if credit quantity decline is small (Gilchrist and Zakrajsek (2011), Adrian, Colla and Shin (2012)) Boundary of firm determines allocation between inventories and net accounts receivable Contracting approach (Antras and Chor (2011)) Details of the financing arrangements are important (Antras and Foley (2011))

60 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 60 Avenues for Future Research (2) Connections with macro literature Can shocks to TFP be financial shocks, after all? Inventory cycles (Blinder and Maccini (1991), Ramey and West (1999)) Trade and inventories (Alessandria, Kaboski and Midrigan (2009, 2010)) Manufacturing demand and durables (Eaton, Kortum, Neiman and Romalis (2010)) Empirics of working capital over the cycle Literature on emerging market crises (Calvo et al.) Panel analysis of firm working capital (Kalemli-Ozcan, Kim, Shin, Sorensen and Yesiltas (in progress))

61 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 61 How Does Leverage Affect Real Economy? Kahle and Stulz (2012) 1 for crisis Firms with no debt cut capital expenditure as much (sometimes more) as firms with debt Adrian, Colla and Shin (2012) 2 Sharp contraction in supply of intermediated credit Shortfall made up by increase in direct credit Cost of both types of financing rise sharply 1 Kahle and Stulz (2012) Access to Capital, Investment and the Financial Crisis 2 Adrian, Colla and Shin (2012) Which Financial Frictions? Parsing the Evidence in the Financial Crisis of

62 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 62 Trillion dollars Corporate bonds Commercial paper Other loans and advances 2.0 Bank loans n.e.c Q1 1991Q3 1993Q1 1994Q3 1996Q1 1997Q3 1999Q1 2000Q3 2002Q1 2003Q3 2005Q1 2006Q3 2008Q1 2009Q3 2011Q1 2012Q3 Total mortgages Figure 12. Credit to US non-financial corporate sector (US Flow of Funds, table L102)

63 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations Millions 120 Bond change Loan change Q2 2009Q4 2008Q2 2006Q4 2005Q2 2003Q4 2002Q2 2000Q4 1999Q2 1997Q4 1996Q2 1994Q4 1993Q2 1991Q4 1990Q2 Figure 13. Changes in outstanding corporate bonds and loans to US non-financial corporate sector. Loans are defined as sum of mortgages, bank loans not elsewhere classified (n.e.c.) and other loans (US Flow of Funds, table F102)

64 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 64 Non-corporate business sector total borrowing (trillion dollars) Q1 1991Q3 1993Q1 1994Q3 1996Q1 1997Q3 1999Q1 2000Q3 2002Q1 2003Q3 2005Q1 2006Q3 2008Q1 2009Q3 2011Q1 2012Q3 other loans and advances depository institution loans n.e.c. commercial mortgages multifamily residential mortgages construction loans on one-tofour family homes home mortgages Figure 14. Credit to US non-corporate business sector (US Flow of Funds, table L103)

65 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations Percent of liabilities Percentage points Expected year-ahead defaults at t-12 (left axis) 10-year high-yield corporate bond spread at t (right axis) Figure 15. Risk premium versus expected default probability (Source: and Zakrajsek (2012)) Egon Zakrajsek, based on Gilchrist

66 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 66 Lending rate Bank credit supply Bond credit supply Aggregate credit supply Credit demand Total credit Figure 16. Bank and bond credit supply before crisis

67 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 67 Lending rate Bank deleveraging Credit demand Total credit Figure 17. Bank and bond credit supply following deleveraging by banking sector

68 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 68 Lending rate Bond financing Bank financing Total credit Figure 18. Bank and bond credit supply following deleveraging by banking sector

69 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 69 Figure 19. Evidence from UK: Cumulative gross issuance of bonds by UK private non-financial corporations (Source: Bank of England Asset Purchase Facility Quarterly Report, 2012 Q3)

70 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 70 How Does Leverage Affect Real Economy? Total quantity of credit (bank and bond) may not be good indicator of financial conditions Composition of credit matters - i.e. bond market relative size of banking sector to Bank deleveraging leads to spike in lending rates in both bank loans and bonds Spike in spreads is followed by economic downturn (Gilchrist and Zakrajsek (2012))

71 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 71 Meanwhile in Europe Bond markets have thawed But credit conditions faced by SME borrowers in Europe are still tight Conjunction of the two explained by subdued banks

72 Se-Jik Kim and Hyun Song Shin: Working Capital, Trade and Macro Fluctuations 72 Figure 20. Non-financial corporate lending rates (source: IMF document on Banking Union in Europe)