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In U.S. business cycles, residential investment differs from consumption and business investment in two respects. First, residential investment leads US GDP, while business investment lags and consumption coincides with U.S. GDP. This lead-lag relationship is supported empirically by and widely studied in existing literature, e.g. in Green (1997) and Leamer (2007). Second, residential investment is more volatile than consumption and business investment. This chapter attempts to explain these two dynamic features of residential investment. This chapter defines the lead-lag relationship using the auto correlation of residential investment, consumption and business investment with GDP. For instance, residential investment leads GDP. What I mean by this is that residential investment has a higher correlation with future GDP than it has with previous and current GDP. Please refer to Appendix 4 for a detailed descriptions of the data and these second moments.
Understanding the dynamics of residential investment and its role in the business cycle is important. The United States’ aggregate housing value constitutes about half of the country’s aggregate private wealth, as documented by Greenwood and Hercowitz (1991). Therefore, the housing market is an important element affecting the behavior of consumption and investment. In addition, residential investment is a good predictor of economic recessions. In the past fifty years, eight of ten recessions (including the most recent one) were preceded by a severe reduction in residential investment, as discussed in Leamer (2007). Indeed, Leamer (2007) suggested that housing is the sector most important to economic recessions, and any attempt to control the business cycle needs to focus particularly on household investment.
Cash management is often ignored in normal times. Usually, it is not until a crisis hits that the management of firms realizes the importance of holding cash. Since the US housing market crashed in 2007, a chain reaction has been occurring—from the insolvency of major financial institutions, job cuts of firms to worldwide economic meltdown. National governments and international financial institutions therefore successively adopted relevant bailout policies or rescue plans to restore the economy at the cost of rising government budget deficit.
The current global economy is characterized by economic slowdown, deflation, reduced interest rate, worsening government budget deficit, elevated credit risk, tighter credit, and other economic difficulties. Facing all these changes in macroeconomic conditions, firms should make the necessary adjustments to sustain their businesses. Cash position, one of the major financial decisions, should not be an exception. It is worth exploring how firms should change cash holdings in response to the changes in macroeconomic conditions. Against this backdrop, the current study therefore aims to examine how macroeconomic conditions influence corporate liquidity (cash holdings) in a global environment, an area which has never been explored in extant literature.
