DP10840 Liquidity, Innovation, and Endogenous Growth

Author(s): Semyon Malamud, Francesca Zucchi
Publication Date: September 2015
Keyword(s): Cash management, Creative destruction, Endogenous growth, Financial constraints, Innovation
JEL(s): D21, G31, G32, G35, L11
Programme Areas: Financial Economics, Macroeconomics and Growth
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10840

We study optimal liquidity management, innovation, and production decisions for a continuum of firms facing financing frictions and the threat of creative destruction. We show that liquidity constraints unambiguously lead firms to decrease their production rate but, surprisingly, may spur investment in innovation (R&D). Using the model, we characterize which firms substitute production for innovation when constrained and thus display a non-monotonic relation between cash reserves and R&D. We embed our single-firm dynamics in a Schumpeterian model of endogenous growth and demonstrate that financing frictions have an ambiguous effect on economic growth.