Small Firms, Business Cycles and Monetary Policy

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The purpose of this research is to analyze the cyclical behavior of small versus large firms, and to understand the differential response of the two kinds of firms with respect to monetary policy. The long run objective is to assess the importance of recent theories which emphasize the role of credit market imperfections in the propagation of business cycles and in the monetary transmission mechanism. The focus on cross-sectional differences in firm behavior at different stages of the business cycle exploits that idea that small firms are more likely than large firms to face problems getting credit. The empirical work centers on examining panel data on real and financial firm variables provided by the Census Bureau. Data is available for firms in the manufacturing, wholesale trade, retail trade, and mining sectors. An important difference with existing panel studies of firm behavior is that the sample distribution of firms is highly representative of the true firm population within each sector. In particular, small firms are more accurately represented. The representative nature of these data will facilitate drawing inferences about the relevance of the results for macroeconomic behavior. An objective is to quantify the impact firms facing financial constraints have on the aggregate volatility of output, inventories, and investment. This research is important because it will provide a better understanding of the interaction of small firm behavior and the business cycle.