The macroeconomic effects of firms' bank dependence and default risk

In modern macroeconomics of imperfect financial markets, the most important source of imperfection is seen in asymmetric information generating agency problems between the firm and its external financial suppliers. Research on the macroeconomics of imperfect capital markets is centred on the behaviour of firms that are financially constrained or bank dependent, and is evolving along three main lines: the determination of macroeconomic variables (output, employment, inflation), the transmission of monetary policy impulses through their effects on credit supply to bank-dependent firms ("bank lending channel") or on firms' self-financing capacity ("net worth channel). The work presented in this paper contributes to the first and second lines, both theoretically and empirically. The basic consequence on which we focus is firms' bank dependence and hence their exposure to bank interest rates and to default risk. First, we present a model that identifies the channels thorough which these factors affect the supply-side of the economy. Then we move to an empirical assessment of the model on the basis of Italian data. Our data set includes monthly observations of real wage rates, average interest rates on bank loans, inter-bank rates as a proxy for the monetary policy stance, a proxy for firms' default risk, inflation and industrial production over the years 1986:1-1998:12. This time period ensures uniformity of data and ends up with Italy's entrance in the euro area which may represent a major regime shift in the data. We have chosen Italy because there are strong priors to believe that firms' bank-dependency is prominent in this country. Our study adds further evidence, but our approach can offer three distinctive contributions of general interest. First, in addition to the traditional demand-side effects of monetary policy, we analyse possible supply-side effects. Second, the demand-side approach has stumbled over an empirical identification problem. As we show, introducing the supply-side of the economy, in particular the joint estimation of the output market and labour market equations, can solve the identification problem while preserving the benefits of the aggregate level of analysis. Finally, our model allows to test whether the interest rate and the default risk premium have distinguishable effects on output. This is a rather new perspective, which may lead to better design of monetary policy interventions. As concerns statistical methodology, we follow Johansen's structural cointegration analysis approach. We find this particularly well suited to our purpose which is to investigate the long-run relationships between financial factors and real variables within a structural model. In fact, this technique allows to decompose the long-run relationships into those which are stationary, the cointegrating relations, and those which are non-stationary, the common trends. Then, a distinction can be drawn between forces that move of variables along their long-run paths and those which produce gravitations around them, while the whole system of forces can be analysed in a single integrated statistical procedure. Our main conclusions are the following. First, as expected, the inter-bank rate and the default risk premium are co-determinants of the equilibrium path of output and inflation. In other words, these variables are non-neutral as they determine with opposite sign the long-run equilibrium values of output and inflation along which short-run dynamics revolve. As regards the inter-bank rate, we find statistical support to the hypothesis that it works through supply-side effects by inducing firms to alter output plans and labour demand permanently. Finally, the estimated long-run impact matrix indicates that, to the extent that the central bank can control the inter-bank rate, it also gains control over both inflation and output.