An empirical financial accelerator model: small firms' investment and credit rationing

According to the financial accelerator model, a small monetary or other shock is amplified through credit market restrictions on small firms, and swings in balance sheets over the business cycle cause swings in small firms' spending. This paper incorporates these notions in an empirical model of firm behavior. We use unit transaction cost of debt and rationed credit as indicators of balance sheets and credit market conditions. Since a firm's credit may or may not be rationed, the empirical model is formulated as a multi-equation switching regression model. This model is estimated for two different groups of small firms in the machinery and equipment industry as reported in the Compustat database. JEL classification: E51; E62 Keywords: Unit transaction cost of debt; Borrowing limit; Switching regression