Staff Reports
The Marginal Propensity to Hire
Number 875
December 2018

JEL classification: E24, E44, G01, G32

Authors: Davide Melcangi

This paper studies the link between firm-level financial constraints and employment decisions, as well as the implications for the propagation of aggregate shocks. I exploit the idea that, when the financial constraint binds, a firm adjusts its employment in response to cash flow shocks. I identify such shocks from changes to business rates, a U.K. tax based on a periodically estimated value of the property occupied by the firm. A 2010 revaluation implied that similar firms, occupying similar properties in narrowly defined geographical locations, experienced different tax changes, allowing me to control for confounding shocks to local demand. I find that, on average, for every £1 of additional cash flow, 39 pence are spent on employment. I label this response the marginal propensity to hire (MPH). I then calibrate a firm dynamics model with financial frictions toward this empirical evidence. As in the data, small and leveraged firms in the model have a greater MPH. Simulating a tightening of credit conditions, I find that the model can account for much of the decline in U.K. aggregate output and employment observed in the wake of the financial crisis.

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AUTHOR DISCLOSURE STATEMENT(S)
Davide Melcangi
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Data used in the paper contains information provided by the Valuation Office Agency under the Open Government Licence v3.0, United Kingdom. The UK Data Service agrees that outputs are non-disclosive, and cannot be used to identify a person or organization. The use of the Business Structure Database (BSD) does not imply the endorsement of the data owner or the UK Data Service at the UK Data Archive in relation to the interpretation or analysis of the data.