By Jorge Miranda-Pinto and Gang Zhang
We show that, unlike any other recession after World War II, sectoral output comovement significantly increased during the Great Recession. On the other hand, trade credit supply, as measured by the ratio of account receivables to the total value of outputs, collapsed during the Great Recession. We show that sectoral comovement was larger for sectors connected through trade credit. We then develop a multisector model with occasionally binding credit constraints and endogenous supply of trade credit to explain these facts. The model shows that equilibrium trade credit reflects both the intermediate supplier’s and client’s bank lending conditions, and thus has asymmetric effects on sectoral outputs. When banking shocks are idiosyncratic, trade credit serves as a mitigation mechanism as firms are able to substitute bank loans for trade credit. However, when banking shocks are strongly correlated, trade credit amplifies the negative financial shock and generates the sharp increase in sectoral comovement observed during the Great Recession. We show that production network models with reduced form wedges are unable to generate this pattern, and that a model with endogenous trade credit amplifies the Great Recession in 18%.
The Great Recession was characterized by a large shock common to all sectors. I suspect we will see the same with the pandemic recession. The same mechanism seems at play: a shocks initially impacts several sectors, and it then filters to others sector, through credit in one recession and through supply chain disruptions in the other.