Elasticity of money in production networks, working capital, credit lines and financial conditions
Summary
Focus
We study how access to on-demand money through credit lines affects firms operating within interconnected supply chains. Specifically, we analyse how changes in financial conditions, which shape the "elasticity of money" (the ability of the financial system to provide liquidity when needed), affect their production and trigger ripple effects throughout the supply chain.
Contribution
We highlight the vital role of money elasticity in supporting smooth economic activity. This is especially important for firms in complex production networks. Our research shows that firms use credit lines to meet their working capital needs, which depend on their position in the supply chain. When financial conditions tighten, firms with higher working capital needs are hit harder by reduced money elasticity. This results in significant drops in output. We also examine how these effects spread through supply chains, amplifying their impact. Our work underscores the importance of money elasticity in maintaining economic stability.
Findings
We find that firms operating in longer supply chains need more working capital. To meet this need, they rely more on credit lines. As a result, when financial conditions tighten, these firms experience larger drops in output. The negative effects spread through supply chains, with upstream firms strongly affecting their downstream customers. Our research also shows that corporate bond spreads and the US dollar exchange rate have a bigger impact on these dynamics than interest rates. These findings emphasise the interconnectedness of supply chains and the crucial role of money elasticity in keeping economic activity stable.
Abstract
The elastic supply of money through overdrafts and credit lines overcomes cash-in-advance con straints, enabling large-value payments without waiting for incoming cash. This elasticity is crucial in long supply chains, where cash-in-advance constraints could otherwise cause gridlock. In essence, money elasticity and the supply of working capital are two sides of the same coin, with undrawn credit lines serving as the operative link. This paper examines how shifts in financial conditions influence money elasticity and, in turn, impact firm activity within produc tion networks. Using granular firm-level data, we demonstrate that production-network-driven working capital needs introduce a cyclical element that dances to the tune of financial conditions. Tighter conditions, such as rising credit spreads or a stronger US dollar, significantly reduce output, with spillovers through production networks amplifying the effects. These findings underscore the importance of money elasticity in supporting economic stability.
JEL classification: E23, E32, E41, E44, E51, F65
Keywords: money elasticity, working capital, credit lines, financial conditions, input-output linkages
