Understanding the Credit Multiplier: The Working Capital Channel

Abstract

We propose and analyze a new mechanism through which financial frictions can affect firms’ operations and economic activity: the working capital credit multiplier. To isolate this multiplier, we develop an identification strategy that builds on cash flow seasonality and allows us to identify funding frictions in working capital without employing pure financial shocks. Our analysis provides evidence that some firms have limited capacity to fund working capital investments, which constraints their production capacity. This mechanism furthers our understanding of how funding frictions amplify and propagate the effects of economic shocks.