EC321-Topic #3 Firms and Credit

There has been widespread reporting of a credit crunch among businesses in the past several months. This has a lot to do with how firms decide to “invest” going into the future. I would like you to think about how the inability to access credit at a low cost has changed the way businesses are deciding how much capital to “rent” and how much labor to hire. Fundamentally, what does the interest rate that firms borrow at have to do with how much labor they hire in the short run and the long run?

The National Federation of Independent Businesses (NFIB) releases surveys monthly on the expected behavior of firms in the near future. You might examine one of these surveys to see how firms are reacting to things like the “credit crunch” or inflationary expectations. Are firms able to raise their prices now while we are in a credit crunch?

Questions you might try to answer:
What does the borrowing interest rate have to do with capital/labor ratios?
How are firms reacting to this shortage of credit?
What can employees expect firms to do in the near/long term with regard to hiring practices?
Would you expect low- or high-skilled labor to benefit (or be harmed) by these changes?

Remember… I would like your statements to be as subjective as possible, or in jargon terms, positive and not normative in nature. Also, remember, I want you to keep your descriptions short, basic, and related to classroom content. Read other students comments before posting, and please leave your name with your posting.

7 thoughts on “EC321-Topic #3 Firms and Credit”

  1. During the September meeting and worried about the looming credit crunch (backed by the sub-prime mortgage rates), the Federal Reserve lowered the funds rate to offset the potential effects of the tighter financial conditions. Policy makers believe that had this not been done, the economy would suffer due to these tightening credit conditions; this would also affect the national employment rates as well. The findings by the National Federation of Independent Business survey concluded that only 3% of business owners confirmed the availability of credit as their number one problem; and many were facing tight labor markets and having trouble filling positions. These percentages and current conditions may compel businesses to borrow more in the present or immediate future (because of the lowered interest rate) with potential for future conditions to tighten; this borrowing will in turn increase the need for a tax and therefore reduce jobs within the economy. Several firms that have suffered from the credit shortage have already announced job cuts earlier today, a trend that may continue within these types firms. Finally, this credit crunch could prove to weaken the economy in the future and discourage workers from borrowing and hiring all together, revealing signs of a recessionary market.-Nick

  2. The credit crunch has raised the interest rate for firms to borrow money. This credit crunch (caused by defaulting borrowers – now affecting firms) has increased the cost of capital. Theoretically [Y = f(K, L)], the increase in the cost of capital should reduce the rate at which firms “rent” capital, and in order to maintain the same production rate in the short run, firms must increase its labor input. In reality, there was a seasonally adjusted decline in average employment for all firms of -0.2 in the month of September (much like August). In addition, capital spending finally showed some life. The frequency of reported capital outlays over the past six months rose two points to 60 percent of all firms. Plans to make capital expenditures over the next few months also gained two points, rising to 29 percent of all firms. [* NFIB Small Business Economic Trends – October 2007] With these results in mind, it seems as though firms are gaining confidence that the credit crunch is on the decline and that the market is beginning to settle.

  3. The borrowing interest rate affects the businesses’ investment pattern: they move from capital to labor and vice-versa. When the interest rate is high the firms are shifting from renting capital, for which due to the increase in interest rate the price is going up, to hire more labor. The increase in borrowing interest rate or the present credit crunch situation would cause the capital/labor ratio to fall (investment in capital will decrease and employment will increase). However, from the NFIB surveys we can find that even firms are willing to hire more workers the skills of labor supplied does not meet the employers’ needs. In some circumstances, employers may hire workers with lower skills than needed and invest in training but at the same time, this would increase the cost of labor. During the period of credit crunch employers will look to substitute capital by labor (if possible), as a short-term solution, but in long run, their investment will be towards capital. As far as which workers, low or high skilled, will benefit more, I think it depends on the nature of the firms but I would see higher chances for low skilled to find a job than for high skilled workers.-Roma

  4. Since the 2001 dot-com bubble, the US has enjoyed very low interest rates. As a result, companies have pursued riskier business strategies because of the low risk/benefit margin. As an aggregate, the United States enjoyed growth through increased capital consumption on borrowed money.Now, seemingly risk-less sectors such as the housing market, have begun to recede. Credit lines for both consumers and businesses have evaporated because investors no longer feel they are being rewarded adequately for their risk. I predict that despite the Fed Funds rate being lower last month, investors will demand more compensation for the risk they hold. As a result, businesses will choose not to invest in the capital-intensive projects that they previously would have because of the higher cost of debt.As Rob and Roma mentioned, employers are having difficulty finding suitable employees at current price levels. I believe that in the short run, wages will increase as demand for quality labor increases. The consumer price index may increase in the short run, however in the long run I see some turbulence. Despite the short run wage increases, consumers have exhausted their credit lines (credit card, home equity) and may not feel comfortable consuming their money, but will try to repay their debt. Corporate profits will become depressed not only by the fearful investor, but also because of the increased demand for skilled workers, and decrease consumption. This is not a formula for long run economic growth.- Eric

  5. Firms wishing to rent “cheap” capitol are facing much difficulty as of recently. The Federal Reserve lowered the interest rate in hopes it would bring more purchasing power and build the economy back up. As the interest rates increased firms saw this has a warning sign in borrowing credit and the market became unstable. Employees were cut to save money for the long run, but more there was still more labor for the short run, rather than credit (as it was more expensive). This was due to the idea that labor would end up cheaper and the firm could save money. As Rob said, employment has declining over the past two months, however the recent bounce back has caused renting capital to increase and it seems firms are gaining confidence once again. The market was very volatile and now seems to be smoothing.Currently, I believe those who are hired skilled have a better chance at maintaining their jobs because the firms want the maximum output with the highest quality and this will be seen in those skilled workers. As Firms are beginning to gain more confidence in the market and interest rates are declining they will start renting capitol again and be able to higher more workers on a variety of levels.

  6. Despite the recent credit concerns in the market, businesses in general have not been harmed too much. Yes, it is more difficult to secure loans, and yes, jobs have not been filled my qualified applicants. However, the credit crunch can be seen as nothing more than an overdue correction to the market. Firms had been lending money to high-risk individuals in an effort to increase the profits from interest rates. Too many people defaulted on their loans, causing the crunch. Firms have responded fairly well to the crunch, despite all the doom and gloom that seems to follow the situation. Even with less access to capital, many businesses plan to continue their spending plans. Unfortunately, because of the lower interest rates, businesses will likely spend more on capital than they will on additional labor. The opportunity exists to make large capital purchases at cheaper rates. This benefit does not extend to the labor market, leading to fewer people being employed. On the other hand, if the crunch becomes extreme, with a lack of credit for all but the most highly qualified, then firms will substitute additional capital with labor. Given that most business expect the economy to recover shortly, and the crunch to end within the next 6 months, I suspect there will be a negligible increase in labor employed, while firms will take advantage of lower interests to build up on their capital. Kail

  7. According to research, now is the most difficult time for small businesses to get loans, yet credit isn’t the primary concern for a majority of owners. Hiring employees is the biggest challenge for many owners of small businesses, despite a rather low unemployment rate of 4.7% in the United States. What this means is that there is a low amount of people in the labor force, which could benefit low-skilled employees. If the small businesses are looking to employ janitors, cashiers, or other positions that require low expertise, then people with limited abilities are in a position to earn decent wages given their skill level. However, it appears that there is structural unemployment at play in this situation, where there are job openings, yet the skill levels required for the jobs do not match up with what the applicants have. Ultimately, those who are unemployed that possess the high skill levels that small businesses are in need of are the ones that will benefit tremendously from the labor shortage.

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