Liquidity and growth: the role of counter-cyclical interest rates

In this paper, we use cross-industry, cross-country panel data to test whether industry growth is positively affected by the interaction between the reaction of real short-term interest rates to the business cycle and industry-level measures of financial constraints. Financial constraints are measured, either by the extent to which an industry is prone to being "credit-constrained", or by the extent to which it is prone to being "liquidity-constrained". Our main findings are that: (i) the interaction between credit or liquidity constraints and the counter-cyclical real short-term interest rate has a positive, significant, and robust impact on the average annual growth rate of industry labor productivity; (ii) these interaction effects tend to be more significant in recessions than in expansions.