Abstract
Can the macroeconomic effects of credit supply shocks be large even when a small share of firms is credit constrained? I use UK firm-level accounting data to discipline a heterogeneous-firm model where the interaction between real and financial frictions induces precautionary cash holdings. In the data, firms increased their cash ratios during the Great Recession, and cash-intensive firms displayed higher employment growth. A tightening of firms’ credit conditions generates the same dynamics in the model. Unconstrained firms preemptively respond to credit supply shocks; this precautionary channel, when appropriately quantified, crucially matters for the aggregate dynamics and firm-level patterns. (JEL D22, E24, E32, E44, G32)
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