The coldblooded researcher in me loved the financial crisis, deep recession, and changes in government policies. Variation in the real world allows us to learn about the real world. But so far, I have seen little research that actually uses these events well. Thinking about how I do research, I think there are three reasons why theory is moving first. First, the most mundane reason: in many cases, data has not become available to test things well yet. Second, theory at this point is easier because the crisis has brought to light lots of relatively-unstudied topics. Economic theory is often about constructing mathematical versions of the theories exposited by market participants. This exercise allows us to check logical arguments, expose prerequisites, and study optimal policy responses. Finally, while a big event would seem to be very informative, it is also very complicated – everything moved. For example, one might think this is a great time to look at how a movement in house prices affects household spending. But when house prices moved, so did the stock market, the local labor market, the national and local deficits, and so forth, so that any change in household spending caused by house prices is conflated with spending movements caused by all sorts of other things.
So what have we learned? The best piece of research that I have seen so far is “Corporate Debt Maturity and the Real Effects of the 2007 Credit Crisis” by Heitor Almeida, Murillo Campello, Bruno A. Laranjeira, and Scott J. Weisbenner. The paper answers two main questions. Did the financial crisis affect real corporate investment? If so, by how much? This is important because we were not sure how important the financial crisis was for real economic activity. Was this a house price collapse leading to a recession in which auto and financial firms were hit hard, or were the financial firms causing a big part of the Great Recession? Some economists argued that the financial crisis was really a sideshow for the real economy.
Almeida et al. compares the real investment of firms that had long-term debt maturing at the start of the crisis to firms that had no long term debt maturing until well after 2008. The beauty of this comparison is that there is little reason why financial decisions from 20 years earlier should be correlated with the appropriate amount of real investment during the crisis other than through difficulties in obtaining funding during the crisis. It turns out that the effect of the chaos in the financial sector was large cuts in corporate investment for those needing funds. The firms without a need to raise a large amount of funds could have cut investment and paid dividends, but instead they maintained investment, presumably because it was profitable despite the high opportunity cost of funds in the crisis. In contrast, firms that needed to raise a lot of capital found the funds unavailable or priced very high, and cut investment, presumably foregoing investment opportunities that would have been profitable absent the financial crisis. In the authors’ words:
“We study whether firms with large portions of their long-term debt maturing right at the time of the crisis observe more pronounced outcomes than otherwise similar firms that need not refinance their debt during the crisis. Firms whose long-term debt was largely maturing right after the third quarter of 2007 reduced investment by 2.5% more (on a quarterly basis) than otherwise similar firms whose debt was scheduled to mature well after 2008. This relative decline in investment is statistically significant and economically large, representing approximately one-third of pre-crisis investment levels.”