Discussion Paper Details

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Title: Liquidity, Innovation, and Endogenous Growth

Author(s): Semyon Malamud and Francesca Zucchi

Publication Date: September 2015

Keyword(s): Cash management, Creative destruction, Endogenous growth, Financial constraints and Innovation

Programme Area(s): Financial Economics and Macroeconomics and Growth

Abstract: 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.

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Bibliographic Reference

Malamud, S and Zucchi, F. 2015. 'Liquidity, Innovation, and Endogenous Growth'. London, Centre for Economic Policy Research.