Working Papers

The inventory/cost ratio is a measure of the time to produce and distribute goods ("time to produce") and, therefore, an important determinant of working capital demand. In the aftermath of emerging market crises, manufacturing industries with higher inventory/cost ratios experienced a larger drop in output, a drop which persisted multiple years into the recovery. This observation is shown to emerge following a persistent foreign interest rate shock in an environment where time to produce in different sectors matches inventory/cost ratios in the data. In such an environment, the interest rate shock is able to account for up to 25% of the deviation of output from its previous trend. In contrast, without time to produce, the interest rate shock generates a boom in the year of the crisis and cannot account for cross-sectoral differences. Likewise, it is impossible to generate cross-sectoral differences of the required magnitude in response to a productivity shock. These results underscore first the importance of working capital constraints as a transmission channel for financial shocks, and second, the importance of persistent interest rate shocks as a driving force of business cycles in emerging economies.