Financial constraints on investment: Effects of firm size and the financial crisis

We estimate the effect of external financial constraints on fixed investment intentions for UK manufacturing by size of firm distinguishing between normal effects and those since the financial crisis began in the UK in 2007. Our financial constraints data are constructed to reflect only supply-side influences i.e. they are independent of cyclical conditions that may affect the demand for credit. Using consistent quarterly long run survey data with IV estimation, we find that only for the crisis period are financial constraints important for large firms and then only for periods of falling business optimism. By contrast, small firms experienced continuous constraint but with no additional supply side effects during the crisis. A policy implication for the UK is that the key to resumed lending may lie not so much with bank behaviour as with the demand conditions that firms face, in particular the sustainability and certainty of demand.