Consumption Risk Sharing over the Business Cycle: The Role of Small Firms' Access to Credit Markets

Consumption risk sharing among U.S. federal states is procyclical - it increases in U.S.-wide booms and decreases in U.S.-wide recessions. These business-cycle fluctuations in inter-state risk sharing are driven mainly by states in which small businesses account for a large share of income or employment. State-level banking deregulation during the 1980s loosened the dependence of interstate risk sharing on the business cycle, mainly through its impact on states with many small firms. Our results establish a major benefit from bank deregulation: small firms’ access to credit and, with it, interstate risk sharing have improved mainly when it is most urgently needed - in nationwide economic downturns.