The recent financial crisis was associated with a large and prolonged deterioration of the credit supply. I build and calibrate a structural model to explore the impact of credit-supply shocks on firm behavior in the context of labor market frictions. I discover that (i) a negative shock to the credit supply can lead to a protracted depression in business activities when firms have a steady level of productivity (demand) and that (ii) a reduction of labor adjustment costs can improve investment and mitigate the negative impact of credit-supply shocks, especially for firms with a high level of productivity. I also empirically corroborate that a lower labor unionization rate can mitigate the negative impact of supply shocks on high-demand firms during a crisis.

It is well documented that since at least the 1970s investment-cash flow (I-CF) sensitivity has been decreasing over time to disappear almost completely by the late 2000s. Based on a neoclassical investment model with costly external financing, we show that this pattern can be explained by the gradual increase of capital adjustment costs, attributable to the accumulation of knowledge capital. The result is robust to a variety of approaches, including Euler equation estimation and the simulated method of moments. More generally, our findings demonstrate that I-CF sensitivity should only be interpreted as a joint measure of financial and real frictions.