Firm Leverage and Boom-Bust Cycles

IMF Working Papers, June 16, 2023

Source details

Sample: data from 24 European economies.
Period covered: 2000-2018.
Firm-level data: large sample of firms (ORBIS referenced in keywords).
Publication details: Pages: 39; Volume: 2023; Issue: 126; Series: Working Paper No. 2023/126; DOI: https://doi.org/10.5089/9798400245282.001; Stock No: WPIEA2023126; ISBN: 9798400245282; ISSN: 1018-5941.

Macro-level relationship between credit to firms and employment:
- A rise in credit to firms is associated with an increase in employment growth in the short-term.
- Employment growth declines in the medium-term following the rise in credit to firms.
- This short-term boost and medium-term decline pattern remains similar when changes in credit to households are accounted for.
Firm-level leverage dynamics and employment:
- Firms with a larger increase in leverage experience a boost in employment growth in the short-term.
- Employment growth for these firms decreases in the medium-term.
- The volatility of employment growth increases in the aftermath of firm leverage buildups.
Financial channel evidence:
- A rise in firm leverage is associated with a persistently higher debt service ratio, indicating a drag on firm finances.
- Boom-bust growth cycles following firm leverage buildups are not limited to employment growth but are also pronounced for investment.
- The medium-term decline in firm employment growth predicted by leverage buildups becomes even larger if aggregate financial conditions tighten.

Leverage buildups predict boom-bust cycles in real outcomes at both macro and firm levels:
- Short-term: credit/leverage buildup → higher employment growth and investment.
- Medium-term: subsequent decline in employment growth and investment, with greater volatility.
Financial constraints appear to amplify medium-term declines:
- Higher debt service ratios persist after leverage buildups.
- Tighter aggregate financial conditions exacerbate the medium-term employment decline.

The findings are in favor of a “lean against the wind” approach in policy making:
- Policies that restrain excessive firm leverage during expansions could reduce subsequent medium-term declines and volatility in employment and investment.
- Monitoring firm leverage buildups and aggregate financial conditions can inform countercyclical measures to mitigate boom-bust real effects.

Subject: Business cycles, Consumer credit, Credit, Credit booms, Economic growth, Employment, Labor, Money
Keywords: boom-bust cycles, Business cycles, Consumer credit, Credit, Credit booms, cycles in the aftermath, employment, employment growth, Europe, firm debt, Firm leverage, Global, growth cycle, household debt, investment, leverage buildup, leverage cycle, leverage cycles, ORBIS

Source: "Firm Leverage and Boom-Bust Cycles", IMF Working Papers 2023, 126 (2023), By Can Sever, June 16, 2023.