A joint CEPR conference with Università di Bergamo was held on 6/8 October on `International Perspectives on the Macroeconomic and Microeconomic Implications of Financial Constraints'. The conference was organized by Marzio Galeotti (Università di Bergamo), Marco Pagano (Università Bocconi and CEPR) and Fabio Schiantarelli (Boston College), and received additional financial support from Boston College.

Bruce Smith (Cornell University and Federal Reserve Bank of Minneapolis) presented the first paper, `Private Information, Money and Growth: Indeterminacy, Fluctuations and the Mundell-Tobin Effect', written with Costas Azariadis. Their work attempts to explain why very high inflation is generally associated with poor performance of the real economy. They propose an overlapping generations model with adverse selection in which the inflation tax on bank deposits encourages households to disintermediate, tightens incentive constraints and induces banks to ration credit. Moreover, dynamic equilibria display dampened endogenous fluctuations around the steady state. John Moore (London School of Economics) expressed concern about the way the paper models money. The authors introduce it as a store of value, the real return on which pins down the real cost of borrowing, which is negative when inflation is positive. This means that the potential supply of loanable funds is always in excess of demand and, as a result, wealth is held in cash. Moore argued that this is too contrived to analyse the real consequences of inflation.

Ramon Marimon (European University Institute, Universitat Pompeu Fabra and CEPR) presented `Recursive Contracts', written with Albert Marcet. These authors show that a general class of contracting problems that involve forward-looking incentive constraints can be cast in a recursive formulation: the optimal solution has a recursive structure once the state variable has been appropriately chosen. Debt repudiation and its reputational effects on the future evolution of the contract is one of the many applications of this methodology. Ernst-Ludwig von Thadden (Universität Basel and CEPR) appreciated the fact that the methodology allows the expression of a large class of optimization problems in a powerful unified theory, and that it has considerable potential for numerical calculations. He could not fully see, however, &nbsphow much substance the new method contributes to established theories of intertemporal consumption smoothing or repeated games.

In `Overreaction of Asset Prices in General Equilibrium', written with Mark Gertler, Rao Aiyagari (Federal Reserve Bank of Minneapolis) proposed a new explanation of the overreaction of asset prices to movements in short-term interest rates, dividends, inflation and asset supplies, cast in a general equilibrium model. The key element of the explanation is the margin constraint which limits traders' short-term debt to a fraction of the value of their assets. When a shock reduces asset prices to a level at which the margin constraint binds, traders are forced to liquidate assets and thus drive asset prices below their fundamental value. Stephen Cecchetti (Boston College) highlighted the fact that, besides excess volatility of asset prices, the model predicts skewness. He wondered whether the model is able to explain other `puzzles' in asset pricing, in particular, if it predicts low and stable riskless rates. He suggested that some simulation results are needed on this issue.

Glenn Hubbard  (Columbia University) &nbsppresented `Using Tax Reforms to Study Investment Decisions: An International Study', written with Kevin Hasset and Jason Cummins. The paper uses firm level panel data and a new estimation method to explore the extent to which fixed investment responds to tax reforms in 13 countries. The authors identify factors that explain why previous studies find that investment does not respond to changes in its marginal costs. Employing an estimation technique that side-steps some of these factors, they find evidence of significant investment responses to tax changes and little evidence that capital market imperfections are an important determinant of investment. Michael Devereux (University of Keele) wondered whether the results may be contaminated by endogeneity bias in the second stage regression used by the authors. He also argued that the problem could be corrected using instrumental variables methods.

Stephen Bond (Nuffield College, Oxford) presented `A Comparison of Empirical Investment Equations using Company Panel Data for France, Germany, Belgium and the UK', written with Julie Elston, Jacques Mairesse and Benoit Mulkay. The paper uses panel datasets for each of the four countries to estimate an accelerator model, an error correction model and an Euler equation model for investment, and to investigate the role played by financial factors in each country. It finds that financial variables play an important role in each country, and that cash flow or profit terms appear to be quantitatively and statistically more significant in the UK than elsewhere. Alessandro Sembenelli (CNR-CERIS) appreciated the comparative nature of the study, but argued that the results could be driven by differences in the samples and not by the different nature of the financial markets. He also suggested that the significance of cash flow may arise not only from its liquidity role, but also from its expectational role.

Fabio Schiantarelli presented `Investment and Financing Constraints: A Switching Regression Approach', written with Xiaoquiang Hu. In their model, firms operate in either a financially constrained or unconstrained regime, and the probability of each regime is endogenously determined in each period. This method is contrasted with the usual procedure for classifying firms in different categories prior to estimation. Maximum likelihood estimates are obtained for a panel of US firms, showing that the behaviour of constrained and unconstrained firms differs. The likelihood of financial constraints depends upon variables that capture each firm's creditworthiness, as well as on general macroeconomic conditions and the tightness of monetary policy. Anil Kashyap (University of Chicago) suggested that the authors' approach is a way to avoid static and dynamic misclassification of firms. &nbspHe noted that the assumption of normality is crucial, however, and the sensitivity of the results to this functional form assumption should be further investigated and tested.

Cesar Alonso-Borrego (Universidad Carlos III de Madrid) presented `Estimating Dynamic Investment Models with Financial Constraints', which estimates Euler equations for investment by Spanish firms, using information on whether firms are paying zero or positive dividends in each time period. The paper also attempts to deal with endogeneity of the sample separation between dividend paying and non-dividend paying firms by adding the inverse of the Mill's ratio to the Euler equations. Costas Meghir (University College London) argued that the author should describe the institutional framework that justifies using dividends as a basis for sample separation, and worried that there is no control for fixed effects. Moreover, he thought that estimation under the alternative is not very fruitful, since rejection of the null may imply that the standard value maximizing problem may not be appropriate.

In `Internal Finance and Investment in Multi-plant Firms', Frode Johansen (Statistics Norway and Northwestern University) studied the relationship between cash flow and fixed investment in a panel of Norwegian manufacturing firms, using the fact that both firm and plant level observations are available. Single plant firms are found to be more sensitive to their own cash flow, but little effect is found from firm's cash flow return on investment of individual plants in multi-plant firms. The paper also analyses whether there are interesting changes in the degree of financial constraints over time, given the profound changes that have occurred in the Norwegian credit market. Jacques Mairesse (ENSAE-CREST) noted that in this, as well as in other papers, the results obtained from Euler equations seem to be very sensitive to the normalization adopted. He provided a detailed analysis of the possible choices open to researchers and of their consequences, suggesting that this problem should be investigated further.

In `Inventory (Dis)Investment, Internal Finance Fluctuations, and the Business Cycle', written with Robert Carpenter and Bruce Petersen, Steven Fazzari (Washington University, Saint Louis) argued that financial constraints lead firms to offset internal financial fluctuations through inventory (dis)investment. The authors construct three panels of quarterly firm data, containing a large fraction of aggregate inventories and covering a major inventory cycle. They show that the impact of internal finance on inventory investment is greater for small firms than for large firms, though internal finance is certainly economically &nbspimportant for large firms. Furthermore, there are important differences in the composition of investment decreases (inventory versus fixed investment) between the 1981–2 and 1990–1 recessions. Marzio Galeotti argued that the paper provided very impressive evidence on financial constraints. But it was time to go beyond the practice of modelling fixed and inventory investment separately; he suggested that they should be analysed in the context of a single structural model.

Stephen Nickell (Oxford University and CEPR) presented `How Does Financial Pressure Affect Firms?', written with Daphne Nicolitsas, which investigates the impact of financial pressure on employment, wages and productivity in a large panel of UK manufacturing firms for the period 1975–86. Both flow and stock measures are used to capture financial pressure, and estimation results suggest that there is a strong negative correlation between measures of financial pressure and employment (holding present and future demand constant), and a smaller negative correlation with wage increases. High leverage also appears to increase firms' productivity, possibly because of the removal of restrictive practices. The results are similar across firms of different size. Gerard Pfann (Rijsuniversiteit Limburg) wondered whether the increase in borrowing costs implies that investment in firm-specific human capital made within the firm is cheaper than hiring new workers. He also argued that the results support the idea that monetary authorities can have a powerful impact on employment.

In `Survival of the Fittest or the Fattest? Exit and Financing in the Trucking Industry', Luigi Zingales (University of Chicago) analysed the impact of capital market imperfections on the survival of firms in the trucking industry. Firms that are highly leveraged when deregulation happens are less likely to survive after deregulation, even controlling for measures of efficiency. This effect, though, is only present in the segment of the market that requires large capital investments and which is not fully competitive. This suggests that capital market imperfections might play a role in the selection process only in industries that are not fully competitive, requiring highly firm-specific investments. Colin Mayer (Oxford University and CEPR) argued that the paper makes a valuable contribution in tracing the effect of an exogenous shock to an industry in which there are segments with and without sunk costs. He suggested, however, that a mis-specification of the probit equations for survival may result from the omission of a wider menu of financial variables. He also worried about measurement errors that occur when accounting measures of rates of returns are used.

Marco Pagano contributed a paper on `The Welfare Effects of Liquidity Constraints', written with Tullio Jappelli, in which the welfare implications of liquidity constraints for households are investigated in an overlapping generations model with growth. The authors show that in a closed, dynamically efficient economy with exogenous technical progress, some degree of financial repression is optimal in the steady state, even though a restrictive policy hurts some generations in the transition. In an open economy with capital mobility, in contrast, financial repression is never optimal at the national level, though generalized capital mobility leads to an inefficiently low steady-state supply of saving at the world level. With endogenous technical progress, financial repression may increase welfare even along the transition path. Luigi Guiso (Banca d'Italia) pointed out that credit is used not only to finance consumption but also to accumulate human capital by households. Limiting households' access to credit raises the stock of physical capital but lowers the stock of human capital. The relationship between liquidity constraints and growth (and thus welfare) then becomes ambiguous.

Yannis Ioannides (Virginia Polytechnic Institute) presented `Unemployment and Liquidity Constraints', written with Vassilis Hajivassiliou. This paper models labour supply and consumption decisions jointly within a utility maximizing framework that allows for institutional constraints such as limited access to credit and involuntary unemployment. The model is estimated via a system of dynamic probit equations, which allows for individual heterogeneity and state dependence. Using data from the Panel Study of Income Dynamics, the results provide strong support for the basic theory of constrained behaviour, particularly for the interaction between liquidity constraints and exogenous constraints on labour supply and their state dependence. Guglielmo Weber (Università di Venezia) was sympathetic to the authors' interpretation. But since credit rationing is proxied in the paper by a low level of assets and rationing in the labour market by an unemployment indicator, the findings are potentially consistent with &nbspan interpretation based on search unemployment. According to this view, the unemployed borrow while searching, and can therefore afford to stay without a job for a relatively long period.

Jorn-Steffen Pischke (MIT) presented `Testing for Liquidity Constraints in Euler Equations with Complementary Data Sources', written with Tullio Jappelli and Nicholas Souleles. This paper argues that previous tests for liquidity constraints using consumption Euler equations are not satisfactory, since they are based on arbitrary splits of the sample. It proposes an alternative methodology, which makes use of direct information on borrowing constraints obtained from the Survey of Consumer Finances. Predicted probabilities of being constrained are then used in a second sample, the Panel Study of Income Dynamics, to estimate a switching regression model for the Euler equation. The estimates obtained with this methodology do not lend much support to the existence of liquidity constraints. Don Cox (Boston College) raised some doubts as to the interpretation of the evidence on liquidity constraints drawn from the Survey. In particular, he wondered if consumers who reply that they are refused credit refer to the consumer credit market or rather to the market for housing loans. In the latter case, they may well not be liquidity constrained in their current consumption decisions, which are the relevant ones for the Euler equation estimates considered in the paper.