Monetary policy and corporate investment: A panel-data analysis of transmission mechanisms in contexts of high uncertainty

Luis P De La Horra,Javier Perote,Gabriel De La Fuente

doi:10.1016/j.iref.2021.04.035

Luis P De La Horra, Javier Perote + Show 1 more

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https://doi.org/10.1016/j.iref.2021.04.035

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Abstract

This paper investigates the impact of monetary policy on firm-level investment in contexts of economic turmoil. Using a panel of US public firms for the period 2000–2019, we show that policy-rate-based transmission mechanisms are undermined when uncertainty spikes. Furthermore, we find evidence of the existence of asymmetries at the firm level. In line with real options theory's predictions, firms with higher levels of investment irreversibility, operational inflexibility, and market power, as well as firms with lower cash flows and who operate in low-innovation sectors tend to be less responsive to changes in monetary policy. The effectiveness of monetary policy thus depends on the ability of monetary authorities to reduce uncertainty via expectations-based monetary tools, whilst targeting those sectors more likely to be affected by monetary-policy shifts.

Highlights

The severity of the 2008 financial crisis and subsequent recession forced US monetary authorities to rethink the traditional transmission mechanisms of monetary policy in order to re-establish pre-crisis levels of investment and employment
Monetary policy seems to be less effective when irreversibility is high. This result appears to provide support for H2: the irreversibility effect increases the value of the option to invest, pushing capital intensive firms to postpone their investments in contexts of high uncertainty
We explore the effectiveness of monetary policy on corporate investment in the presence of high uncertainty

Summary

Introduction

The severity of the 2008 financial crisis and subsequent recession forced US monetary authorities to rethink the traditional transmission mechanisms of monetary policy in order to re-establish pre-crisis levels of investment and employment. This reassessment of monetary policy went along two lines. The sluggish recovery pushed monetary authorities to employ expectations-based mechanisms such as forward guidance in order to lower uncertainty and spur economic activity. Whereas Smith and Becker (2015) and Katagiri (2016) show that forward guidance is a powerful tool to stimulate the economy when the policy rate is constrained (http://creativecommons.org/licenses/by/4.0/)

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